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Sauer-Danfoss ARS 2009

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NOTICE OF 2009 ANNUAL MEETING

PROXY STATEMENT FOR 2009 ANNUAL MEETING

2008 ANNUAL REPORT


TABLE OF CONTENTS

 
   
  Page No.

I.

 

Notice of 2009 Annual Meeting

 

I-1

II.

 

Proxy Statement

 

II-1

 

 

    General Information

 

II-1

 

 

        Solicitation and Revocability of Proxies

 

II-1
            Expense of Solicitation   II-1
            Voting of Proxies   II-1
            Persons Entitled to Vote   II-2

 

 

    Security Ownership of Certain Beneficial Owners and Management

 

II-3

 

 

    Change in Control Transaction

 

II-4

 

 

    Governance of the Company

 

II-6

 

 

        Board of Directors

 

II-6
            Basis for Board Determination of Independence of Directors   II-6
            Audit Committee   II-7
            Compensation Committee   II-8
            Nominating Committee   II-8
            Consideration of Nominees, Qualifications and Procedures   II-8
            Agreement Regarding Nominees for Director   II-9
            Stockholder Communications with the Board   II-10
            Code of Conduct and Code of Ethics   II-10
            Transactions with Related Persons   II-10
            Review, Approval or Ratification of Transactions with Related Persons   II-11

 

 

    Report of the Audit Committee

 

II-12

 

 

    Executive Compensation

 

II-13

 

 

        Compensation Discussion and Analysis

 

II-13

 

 

            Role of Compensation Committee and Management in Executive
                Compensation Matters

 

II-13
                Executive Compensation Goals and Objectives   II-13
                Hewitt Market Review—2008   II-15
                Elements of Executive Compensation Program   II-15

 

 

                Base Salary

 

II-16
                    Annual Incentive Awards   II-16
                    Long-Term Incentive Awards   II-17
                    Retirement & Savings Plans   II-20
                    Additional Cash Compensation and Perquisites   II-22
                    Other Potential Post-Employment Compensation   II-23

 

 

            Dave Anderson Retirement and Post-Employment Compensation

 

II-23
                New CEO Hiring & Compensation Elements   II-23
                2009 Actions In Response To Economic & Market Downturn   II-24
                Stock Ownership Guidelines   II-24
                Financial Accounting and Tax Impacts of Executive Compensation Program   II-24
                Compensation Committee Interlocks and Insider Participation   II-24
                Compensation Committee Report   II-25

 

 

Summary Compensation Table

 

II-26

 
   
  Page No.
    Grants of Plan-Based Awards Table   II-28
    Summary Compensation And Grants Of Plan-Based Awards Narrative   II-29
            Stock Awards   II-29
            Non-Equity Incentive Compensation   II-30

 

 

    Outstanding Equity Awards At Fiscal Year-End Table

 

II-31
        Option Exercises and Stock Vested Table   II-32
        Pension Benefits Table   II-32
        Pension Benefits Narrative   II-32

 

 

        Sauer-Danfoss Employees' Retirement Plan

 

II-32
            Sauer-Danfoss Supplemental Retirement Plan   II-33
            German Company Pension Scheme   II-34

 

 

    Nonqualified Deferred Compensation Table

 

II-34
        Nonqualified Deferred Compensation Narrative   II-35

 

 

        Elective Deferred Compensation Plans for Cash Compensation

 

II-35
            Elective Deferred Compensation Plan for Long-Term Incentive Compensation   II-35
            Supplemental Executive Savings and Retirement Plan   II-36

 

 

    Potential Payments Upon Termination or Change in Control

 

II-37

 

 

        Potential Payments Upon Termination or Change in Control Table

 

II-37

 

 

            Payments Due To Death Or Disability

 

II-38
                Payments Due To Termination By Company Without Cause & Termination By
                Employee With Good Reason
  II-38
                Payments Following A Change In Control   II-39
                Key Employment Agreement Provisions   II-40

 

 

    Director Compensation Table

 

II-40
        Director Compensation Narrative   II-41

 

 

Item 1—Election of Directors

 

II-42

 

 

    Nominees to Serve for Directors

 

II-42

 

 

Item 2—Ratification of Appointment of Independent Registered Public Accounting Firm

 

II-44

 

 

    Fees to Independent Registered Public Accounting Firm for 2008 and 2007

 

II-44
        Policy Regarding Pre-Approval of Audit and Non-Audit Services of Independent
        Registered Public Accounting Firm
  II-45

 

 

Additional Information

 

II-45

 

 

    Notice Requirements

 

II-45
        Discretionary Authority   II-45
        Section 16(a) Beneficial Ownership Reporting Compliance   II-46
        Form 10-K   II-46

III.

 

2008 Annual Report

 

III-1

 

 

    Business

 

III-1
        NYSE Price Range, Dividends by Quarter   III-1
        Certifications   III-1
        Performance Graph   III-2
        Management's Discussion and Analysis of Financial Condition and Results of
        Operations
  III-3
        Consolidated Statements of Operations   III-21
        Consolidated Balance Sheets   III-22

 
   
  Page No.
        Consolidated Statement of Stockholders' Equity and Comprehensive Income (Loss)   III-23
        Consolidated Statements of Cash Flows   III-24
        Notes to Consolidated Financial Statements   III-25
        Report of Management   III-60
        Report of Independent Registered Public Accounting Firm   III-61
        Selected Financial Data   III-63
        Chairman, Vice Chairmen and Chairman Emeritus   III-65
        Corporate Data   III-66

SAUER-DANFOSS INC.
250 Parkway Drive, Suite 270
Lincolnshire, Illinois 60069

NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD JUNE 11, 2009

TO OUR STOCKHOLDERS:

        The annual meeting of stockholders of Sauer-Danfoss Inc., a Delaware corporation, will be held at Sauer-Danfoss GmbH & Co. OHG, Krokamp 35, 24539 Neumünster, Germany on Thursday, June 11, 2009, commencing at 8:30 a.m. local time. At the meeting, stockholders will act on the following matters:

    1.
    To elect ten (10) directors for a term expiring at the annual meeting of stockholders to be held in 2010 and until their respective successors are duly elected and shall qualify.

    2.
    To ratify the appointment of KPMG LLP as the Company's independent registered public accounting firm for 2009.

    3.
    To transact such other business as may properly come before the meeting or any postponement or adjournment.

Stockholders of record at the close of business on April 16, 2009 are entitled to notice of and to vote at the annual meeting or any postponement, adjournment, or adjournments.

* * * * *

IMPORTANT NOTICE REGARDING THE AVAILABILITY OF PROXY MATERIALS FOR THE
ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON JUNE 11, 2009

        This Proxy Statement and Annual Report to Stockholders is available on the internet at http://ir.sauer-danfoss.com under the tab Proxy Online.

* * * * *

        Whether or not you expect to attend the Annual Meeting, please either complete, date, sign, and return the accompanying proxy card in the provided envelope or vote your shares by telephone or via the Internet using the instructions on the enclosed proxy card as promptly as possible in order to ensure your representation at the meeting. Even if you have given your proxy, whether by mail, by telephone, or via the Internet, you may still vote in person if you attend the meeting. If your shares are held of record by a broker, bank, or other nominee ("Street Name") you will need to obtain from the institution that holds your shares and bring to the meeting a proxy issued in your name, authorizing you to vote the shares.

                        By order of the Board of Directors,

                        GRAPHIC


                        Kenneth D. McCuskey
                        Corporate Secretary

Lincolnshire, Illinois
April 29, 2009

I-1


SAUER-DANFOSS INC.
250 Parkway Drive, Suite 270
Lincolnshire, Illinois 60069



PROXY STATEMENT

April 29, 2009



GENERAL INFORMATION

Solicitation and Revocability of Proxies

        The enclosed proxy is being solicited on behalf of the Board of Directors of Sauer-Danfoss Inc. (the "Company") for use at the annual meeting of the stockholders to be held on June 11, 2009 (the "Annual Meeting"), and at any postponement or adjournment. Most stockholders have a choice of voting via the Internet, by using a toll-free telephone number, or by completing a proxy card and mailing it in the envelope provided. Check your proxy card or the information forwarded by your bank, broker, or other holder of record to see which options are available to you. Please be aware that if you vote over the Internet, you may incur costs such as telecommunication and Internet access charges for which you will be responsible. The telephone voting facilities and the Internet voting facilities for stockholders of record will be available until 11:59 p.m. CDT on June 9, 2009, two days prior to the Annual Meeting.

        Any proxy given does not affect your right to vote in person at the meeting and may be revoked at any time before it is exercised by notifying Kenneth D. McCuskey, Corporate Secretary, by mail, telegram, or facsimile, by timely delivery of a properly executed, later-dated proxy (including an Internet or telephone vote) or by appearing at the Annual Meeting in person and voting by ballot. Persons whose shares are held of record by a brokerage house, bank, or other nominee and who wish to vote at the meeting, must obtain from the institution holding their shares a proxy issued in such person's name.

        The Company intends to mail this Proxy Statement and the accompanying proxy on or about April 29, 2009.

Expense of Solicitation

        The Company will bear the entire cost of solicitation of proxies, including the preparation, assembly, printing, and mailing of this Proxy Statement, the accompanying proxy and any additional information furnished to stockholders. The Company will reimburse banks, brokerage houses, custodians, nominees, and fiduciaries for reasonable expenses incurred in forwarding proxy material to beneficial owners. In addition to solicitations by mail, officers, other regular employees and directors of the Company may, but without compensation other than their regular compensation, solicit proxies in person or by telephone, facsimile or electronic means.

Voting of Proxies

        All shares entitled to vote and represented by properly completed proxies received prior to the Annual Meeting and not revoked will be voted in accordance with the instructions on the proxy. If no instructions are indicated on a properly completed proxy, the shares represented by that proxy will be voted for the election of the nominees for director designated below and for ratification of the appointment of KPMG LLP as independent registered public accounting firm of the Company for 2009.

II-1


Persons Entitled to Vote

        Only holders of common stock of the Company of record as of the close of business on April 16, 2009 are entitled to notice of and to vote at the Annual Meeting. At the close of business on that date, 48,368,352 shares of common stock were outstanding. Holders of common stock are entitled to one (1) vote for each share held on all matters to be voted upon. Shares cannot be voted at the Annual Meeting unless the owner is present in person or represented by proxy. The directors shall be elected by an affirmative vote of a plurality of the shares that are entitled to vote on the election of directors and that are represented at the meeting by stockholders who are present in person or by proxy, assuming a quorum is present. The ten nominees for director receiving the greatest number of votes at the Annual Meeting will be elected as directors.

        For all other matters to be voted upon at the Annual Meeting, the affirmative vote of a majority of shares present in person or represented by proxy, and entitled to vote on the matter, is necessary for approval.

        When a broker or other nominee holding shares for a customer does not vote on a proposal because the broker or nominee does not have discretionary voting power with respect to such proposal and has not received instructions from the beneficial owner, it is referred to as a "Broker Nonvote." Properly executed proxies marked "Abstain" or proxies required to be treated as "Broker Nonvotes" will be treated as present for purposes of determining whether there is a quorum at the meeting. Abstentions will be considered shares entitled to vote in the tabulation of votes cast on proposals presented to the stockholders and will have the same effect as negative votes. Broker Nonvotes are counted towards a quorum but are not counted for any purpose in determining whether a matter has been approved.

II-2



SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        The following table sets forth certain information as of April 16, 2009, with respect to shares of common stock of the Company that were owned beneficially by: (i) each beneficial owner of more than 5% of the outstanding shares of common stock; (ii) each of the directors; (iii) each of the named executive officers of the Company; and (iv) all executive officers and directors of the Company as a group.

Beneficial Owners, Directors, and Executive Officers
  Number of Shares
Beneficially
Owned (1)
  Percent of
Outstanding
Shares
 

Danfoss A/S(2)

    36,629,787 (3)   75.7 %

Sauer Holding GmbH(4)

    36,629,787 (3)   75.7 %

Danfoss Murmann Holding A/S(2)

    18,241,962 (5)   37.7 %

Sven Ruder, Director, President and Chief Executive Officer

    1,500     *  

David J. Anderson, Co-Vice Chairman, Former President and Former Chief Executive Officer(6)

    93,193     *  

Hans J. Cornett, Executive Vice President and Chief Marketing Officer

    38,658     *  

Thomas K. Kittel, Executive Vice President and President—Propel Division

    164,564     *  

Karl J. Schmidt, Former Executive Vice President and Former Chief Financial Officer

    42,973     *  

Wolfgang Schramm, Executive Vice President and President—Controls Division

    18,365     *  

Niels B. Christiansen, Director

    1,500     *  

Jørgen Clausen, Director and Chairman

    70,000     *  

Kim Fausing, Director

    1,500     *  

William E. Hoover, Jr., Director

    1,500     *  

Johannes F. Kirchhoff, Director

    13,400     *  

Frederik Lotz, Director

    1,500     *  

F. Joseph Loughrey, Director

    14,000 (7)   *  

Sven Murmann, Director and Vice Chairman

    13,000     *  

Steven H. Wood, Director

    9,000     *  

All directors and executive officers as a group (17 persons)

    427,432 (8)   *  

*
Represents less than 1%.

(1)
Unless otherwise indicated in the following notes, each of the stockholders named in this table has sole voting and investment power with respect to the shares shown as beneficially owned. The following footnotes describe those shares which are beneficially owned by more than one person listed above.

(2)
The mailing address for each of these entities is Nordborgvej 81, 6430 Nordborg, Denmark.

(3)
These shares include 18,241,962 shares owned directly by Danfoss Murmann Holding A/S (the "Holding Company"), 9,865,614 shares owned directly by Sauer Holding GmbH ("Sauer Holding"), 8,358,961 shares owned directly by Danfoss A/S, and 163,650 shares owned directly by SDW Stiftung Deutsche Wirtschaft, a German foundation (the "Stiftung"). As a result of its 100% voting power over the Holding Company, Danfoss A/S has shared voting and dispositive power over the 18,241,962 shares owned directly by the Holding Company. All of these shares are subject to the voting agreements contained in the Stockholders Agreement dated July 11, 2008, by and between Danfoss A/S and Sauer Holding (the "Stockholders Agreement"). By virtue of its ownership of the Holding Company and the provisions of the Stockholders Agreement, Danfoss A/S has shared voting and dispositive power over all of these shares except the 8,358,961 shares it owns directly, over which

II-3


    it has shared voting and sole dispositive power. By virtue of the provisions of the Stockholders Agreement and an agreement with the Stiftung, Sauer Holding has shared voting power over all of these shares and shared dispositive power over the 9,865,614 shares it owns directly and the 163,650 shares owned directly by the Stiftung. Danfoss A/S disclaims beneficial ownership of all of these shares except for the 8,358,961 shares it owns directly. Sauer Holding disclaims beneficial ownership of all of these shares except for the 9,865,614 shares it owns directly.

(4)
The mailing address for Sauer Holding GmbH is Krokamp 35, 24539 Neumünster, Germany.

(5)
As a result of the Holding Company's status as a wholly owned subsidiary of Danfoss A/S, all of these shares, which are directly owned by the Holding Company, are subject to the terms of the Stockholders Agreement; therefore, the Holding Company has shared voting and sole dispositive power over these shares.

(6)
Mr. Anderson retired as the Company's President and Chief Executive Officer effective December 31, 2008. Although he is not presently serving as a director of the Company, he continues to serve as the Co-Vice Chairman of the Board in a non-voting, advisory capacity.

(7)
Mr. Loughrey disclaims beneficial ownership with respect to 3,000 of these shares which are owned directly by his wife.

(8)
Includes stock owned by the spouses and children of certain directors and executive officers. These shares do not include the shares reported above that are owned by Mr. Anderson or Mr. Schmidt, who were not directors or executive officers of the Company as of April 16, 2009.

Change in Control Transaction

        On March 10, 2008, Danfoss A/S ("Danfoss") and Sauer Holding GmbH ("Sauer Holding") entered into a Share Purchase Agreement (the "Purchase Agreement") pursuant to which Danfoss agreed to purchase, and Sauer Holding agreed to sell, a controlling interest in the Company (the "Share Purchase Transaction"). The closing of the Share Purchase Transaction resulted in a change in control of the Company, as Sauer Holding sold to Danfoss (i) 8,358,561 shares of the Company's common stock and (ii) all of the remaining issued and outstanding shares of Danfoss Murmann Holding A/S, a Danish corporation that was jointly owned by Sauer Holding and Danfoss (the "Holding Company"). By virtue of the Share Purchase Transaction, control of a majority of the issued and outstanding shares of the Company's common stock shifted from Danfoss and Sauer Holding jointly, to Danfoss alone.

        At closing of the Share Purchase Transaction, Sauer Holding and Danfoss executed a Stockholders Agreement (the "Stockholders Agreement") that replaced the Joint Venture Agreement, dated January 22, 2000, as amended as of February 22, 2000, by and among Danfoss, Sauer Holding and the Holding Company (the "Joint Venture Agreement"), in governing the rights and obligations of the parties with respect to their ownership and control of the Company and the Company's common stock that they hold (including arrangements with respect to the composition of the Company's Board of Directors and the consequent alteration of the existing rights of Danfoss and Sauer Holding with respect to the nomination of members of the Company's Board of Directors).

        The Share Purchase Transaction and the Stockholders Agreement altered Sauer Holding's and Danfoss' respective rights to nominate members of the Company's Board of Directors. As was the case under the Joint Venture Agreement, the Stockholders Agreement provides that the Company's Board of Directors will consist of ten (10) members. However, under the Stockholders Agreement, Sauer Holding possesses nomination rights with respect to two such members (one independent and one non-independent member) and Danfoss possesses nomination rights with respect to eight such members (two independent and six non-independent members) (each determination of independence to be made in accordance with the rules of the New York Stock Exchange).

II-4


        The Share Purchase Transaction and the Stockholders Agreement furthermore resulted in the creation of various new contractual rights and obligations of Sauer Holding and Danfoss vis-à-vis one another related to transfers of Company common stock by them. Under the Stockholders Agreement, Sauer Holding granted to Danfoss the right to purchase from Sauer Holding (via exercise of a call option), and Danfoss granted to Sauer Holding the right to sell to Danfoss (via exercise of a put option), the remaining 10,029,264 shares of Company common stock held by Sauer Holding, in two equal stages of 5,014,632 shares each, during the 21-day windows of time (starting on August 1, 2010 and August 1, 2012, respectively) following the delivery of the Company's audited financial statements to Sauer Holding for the Company's 2009 and 2011 fiscal years, respectively. The exact purchase price for the shares subject to the call option and put option will be calculated based on the Company's operating income and adjusted with respect to the net debt level in the 2009 and 2011 fiscal years, respectively, but will fall within the range of $29.67 and $49.45 per share, subject to adjustment as a result of stock splits, reclassifications of stock, combinations of stock, or similar transactions. Under the Stockholders Agreement, Danfoss has the right, at any time, to accelerate its exercise of either or both stages of the call option by electing to purchase Sauer Holding's shares of Company common stock subject to such option at a price equal to $49.45 per share, subject to adjustment as a result of stock splits, reclassifications of stock, combinations of stock, or similar transactions. Sauer Holding, on the other hand, is entitled to accelerate its exercise of either or both stages of its put option and to sell its shares of Company common stock subject to such option to Danfoss at a price equal to $29.67 or $39.56 per share (depending on the identity of the third party involved in the transaction giving rise to the acceleration right), subject to adjustment as a result of stock splits, reclassifications of stock, combinations of stock, or similar transactions, only under certain limited circumstances.

        In addition to the put and call options, the Stockholders Agreement provides for drag-along rights and a right of first refusal for Danfoss, and tag-along rights for Sauer Holding. These rights would apply in the case of a proposal by either Danfoss or Sauer Holding to sell shares of Company common stock to a third party. The number of shares subject to the put and call options is subject to reduction based on shares of Company common stock sold by Sauer Holding as a result of Danfoss' exercise of drag-along rights or Sauer Holding's exercise of tag-along rights under the Stockholders Agreement.

II-5



GOVERNANCE OF THE COMPANY

Board of Directors

        The Company's Board of Directors (the "Board") currently has ten members, three of whom meet the New York Stock Exchange standard for independence. The Board has an Audit Committee and a Compensation Committee. All members of the Audit Committee and Compensation Committee are independent directors. The corporate governance listing standards of the New York Stock Exchange provide that a company of which more than 50% of the voting power is held by an individual, a group or another company (a "controlled company") need not comply with the Exchange's listing standards requiring that a majority of the Board be independent and that listed companies have a nominating/corporate governance committee and a compensation committee each composed entirely of independent directors with a written charter that addresses specific items. The Company considers itself to be a controlled company because approximately 75.8% of the voting power of the Company's common stock is owned or controlled by Danfoss A/S. Accordingly, the Company has elected to utilize the exemption from the requirement that a majority of the Board be independent and from the provisions relating to a nominating/corporate governance committee.

        The Board held four meetings and one telephonic meeting during 2008. Each director attended at least 75% of the aggregate of the total number of meetings of the Board and the total number of meetings held by all committees of the Board on which the directors served during 2008. It is the policy of the Board that each director of the Company is expected to attend annual meetings of the stockholders of the Corporation, it being understood, however, that a director infrequently may be unable to attend annual meetings of the stockholders of the Company due to illness, a previously scheduled meeting of importance or other irreconcilable conflict. All of the directors attended the Company's annual stockholders meeting that commenced and was adjourned in June of 2008, and all but one of the directors attended the completion of the adjourned meeting in July of 2008.

        The non-management directors of the Company have adopted a schedule to meet in private session at the end of or prior to each regular meeting of the Board without any management director or executive officer being present. The non-management directors have also adopted the policy that the Chairman of the Board, or in his absence, the Vice Chairman, shall preside at all such meetings. In addition, at least once a year, only independent, non-employee directors shall meet in private session.

Basis for Board Determination of Independence of Directors

        The Board has adopted Corporate Governance Guidelines (the "Guidelines") that provide, among other things, that at least three directors must be independent. The Guidelines can be viewed on the Company's investor relations website at http://ir.sauer-danfoss.com, and the Company will mail, without charge, a copy of the Guidelines upon written request to Kenneth D. McCuskey, Corporate Secretary at 2800 East 13th Street, Ames, Iowa 50010. To be considered "independent" under the Guidelines, a person must be determined by the Board to have no material relations, directly or indirectly, with the Company or its affiliates or any other director or elected officer of the Company, and must otherwise be independent as that term is defined under the listing standards of the New York Stock Exchange, but also without the appearance of any conflict in serving as a director. In addition to applying these guidelines, the Board shall consider all relevant facts and circumstances in making an independence determination.

        The Board undertook its annual review of director independence with respect to the three persons considered independent at its meeting on March 18, 2009. The Board determined whether the three persons under consideration met the objective listing standards of the New York Stock Exchange regarding the definition of "independent director," which standards provide that a director is not independent if:

    The director is, or has been within the last three years, an employee of the Company, or an immediate family member is, or has been within the last three years, an executive officer of the Company.

II-6


    The director has received, or has an immediate family member who has received, during any twelve-month period within the last three years, more than $120,000 in direct compensation from the Company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service).

    (A) The director is a current partner or employee of a firm that is the Company's internal or external auditor; (B) the director has an immediate family member who is a current partner of such firm; (C) the director has an immediately family member who is a current employee of such a firm and personally works on the Company's audit; or (D) the director or an immediate family member was within the last three years a partner or employee of such a firm and personally worked on the Company's audit within that time.

    The director or an immediate family member is, or has been within the last three years, employed as an executive officer of another company where any of the Company's present executive officers at the same time serves or served on that company's compensation committee.

    The director is a current employee, or an immediate family member is a current executive officer, of a company that has made payments to, or received payments from, the Company for property or services in an amount which, in any of the last three fiscal years, exceeds the greater of $1 million or 2% of such other company's consolidated gross revenues.

        The Board also considered whether there were any other transactions or relations between each of said three persons or any member of his immediate family and the Company and its subsidiaries and affiliates that would affect the independence of such persons and concluded that there were none.

        As a result of its review, the Board affirmatively determined that Johannes F. Kirchhoff, F. Joseph Loughrey and Steven H. Wood are independent of the Company and its management under the standards set forth in the Guidelines.

Audit Committee

        The Audit Committee is currently composed of three directors, none of whom is an employee of the Company. The Audit Committee currently consists of Messrs. Wood (Chairman), Kirchhoff and Loughrey. All of the members of the Audit Committee are independent within the meaning of the Securities and Exchange Commission's ("SEC") regulations, the current listing standards of the New York Stock Exchange and the Company's Corporate Governance Guidelines. In addition, the Board has determined that at least one member of the Audit Committee meets the New York Stock Exchange listing standard of having accounting or related financial management expertise.

        The Board has also determined that Steven H. Wood meets the SEC's criteria of an "audit committee financial expert." Mr. Wood's extensive background and experience includes presently serving as Chief Financial Officer of Becker-Underwood, Inc., a supplier of non-pesticide specialty chemical and biological products within the agricultural, landscape, turf, and horticulture industries, and formerly serving as Vice President and Corporate Controller of Metaldyne Corporation, a global designer and supplier of metal-based components, assemblies and modules for the automotive industry, and before that as Executive Vice President and Chief Financial Officer of Maytag Corporation. Prior to joining Maytag, he was an auditor with Ernst & Young, a public accounting firm, and successfully completed the examination for Certified Public Accountants. Mr. Wood is independent as that term is used in the New York Stock Exchange's listing standards relating to director independence.

        The Audit Committee is directly responsible for the appointment, compensation, retention and oversight of the independent registered public accounting firm. The Committee also reviews the scope of the annual audit activities of the independent registered public accounting firm and the Company's internal auditors, reviews audit and quarterly results and administers the Worldwide Code of Legal and

II-7



Ethical Business Conduct and the Code of Ethics for Chief Executive Officer, Chief Financial Officer, Principal Accounting Officer or Controller and Other Senior Finance Staff. All of the Committee's duties and responsibilities are set forth in a written Audit Committee Charter. The Charter can be viewed on the Company's investor relations website at http://ir.sauer-danfoss.com and the Company will mail, without charge, a copy of the Audit Committee Charter upon written request to Kenneth D. McCuskey, Corporate Secretary at 2800 East 13th Street, Ames, Iowa 50010. The Audit Committee held four meetings and four telephonic meetings during 2008.

Compensation Committee

        The Compensation Committee is currently composed of three directors, none of whom is an employee of the Company. The current members of the Compensation Committee are Messrs. Kirchhoff (Chairman), Loughrey and Wood, all of whom are independent as defined under the current listing standards of the New York Stock Exchange. The Compensation Committee reviews and determines the salaries of the executive officers of the Company and administers the Company's Annual Officer Performance Incentive Plan, the 1998 Long-Term Incentive Plan, the 2006 Omnibus Incentive Plan, the Deferred Compensation Plan for Selected Employees, the 409A Deferred Compensation Plan for Selected Employees, and the Supplemental Executive Savings & Retirement Plan. All of the duties of the Compensation Committee are set forth in a written Charter last amended and restated as of April 27, 2005, which can be viewed on the Company's investor relations website at http://ir.sauer-danfoss.com and the Company will mail, without charge, a copy of the Compensation Committee Charter upon written request to Kenneth D. McCuskey, Corporate Secretary at 2800 East 13th Street, Ames, Iowa 50010. The Compensation Committee held four meetings and one telephonic meeting in 2008.

Nominating Committee

        Following completion of the acquisition in 2008 by Danfoss A/S of a controlling interest in the Company from entities and persons associated with Klaus H. Murmann, Chairman Emeritus of the Company, the Board abolished the Company's Nominating Committee. Pursuant to the Stockholders Agreement dated July 10, 2008 (the "Stockholders Agreement") by and between Danfoss A/S and Sauer Holding GmbH, Danfoss A/S has the right to submit the names of six non-independent and two independent persons to be nominated as directors, and Sauer Holding GmbH has the right to submit the names of one non-independent and one independent person to be nominated as directors. In light of the terms of the Stockholders Agreement, the Board believes it is appropriate for the Company not to have a Nominating Committee. The Board makes the final nominations pursuant to the guidelines set forth below.

Consideration of Nominees, Qualifications and Procedures

        The Board adopted the policy in July 2008 that it will continue the former Nominating Committee's practice to consider qualified candidates for director that are suggested by stockholders. Stockholders can recommend qualified candidates for director by writing to: Chairman of the Board of Directors, Attention: Kenneth D. McCuskey, Corporate Secretary, Sauer-Danfoss Inc., 2800 East 13th Street, Ames, Iowa 50010. Recommendations should set forth detailed information regarding the candidate, including the person's background, education, business, community and educational experience, other Boards of Directors of publicly held corporations on which the candidate currently serves or has served in the past and other qualifications of the candidate to serve as a director of the Company. All recommendations must be received by January 1 in order to be considered as a nominee for director at the annual meeting of stockholders to be held in such year. Recommendations that are received that meet the conditions set forth above shall be forwarded to the Board for further review and consideration.

II-8


        In evaluating director nominees, the Board considers, among other things, the following factors:

    The needs of the Company with respect to the particular talents and experience of its directors

    The extent to which the candidate would contribute to the range of talent, skill and expertise appropriate for the Board

    The ability of the candidate to represent the interests of the stockholders of the Company

    The candidate's standards of integrity, commitment and independence of thought and judgment

    The candidate's ability to dedicate sufficient time, energy and attention to the diligent performance of his or her duties as a director of the Company, taking into account the candidate's services on other boards, including public and private company boards as well as not-for-profit boards, and other business and professional commitments of the candidate

    The knowledge, skills and experience of the candidate, including experience in the Company's industry, business, finance, administration or public service, in light of prevailing business conditions

    Experience with accounting rules and practices

    Familiarity with national and international business matters

    The desire to balance the considerable benefit of continuity with the periodic injection of the fresh perspective provided by new members

        The Board also considers such other relevant factors as it deems appropriate, including the current composition of the Board, the need for independent directors, the need for Audit Committee expertise and the evaluations of other candidates. Other than considering the factors set forth above, there are no stated minimum criteria for director nominees.

        The Board identifies candidates by first evaluating the current members of the Board willing to continue in service. If any member of the Board does not wish to continue in service or if the Board decides not to re-nominate a member for election to the Board, the Board shall identify the desired skills and experience of a new candidate in light of the factors set forth above. Current members of the Board may be polled for suggestions as to individuals meeting the criteria of the Board, and qualified candidates recommended by stockholders shall be considered. Research may be performed to identify qualified individuals. The Board may, but shall not be required to, engage third parties to identify or evaluate or assist in identifying potential candidates. The Board has from time to time utilized an executive search firm to assist in identifying potential candidates.

        In connection with its evaluation of candidates, the Board shall determine which, if any, candidates shall be interviewed, and if warranted, one or more members of the Board, and others as appropriate, shall interview prospective candidates in person or by telephone. After completing this evaluation and interview process, the Board shall determine the nominees.

Agreement Regarding Nominees for Director

        Sauer Holding GmbH and Danfoss A/S are parties to the Stockholders Agreement, which contains certain agreements regarding their ownership and voting of the Company common stock owned and controlled by them. Pursuant to the Stockholders Agreement, Sauer Holding GmbH will identify one non-independent and one independent candidate for director and Danfoss will identify six non-independent and two independent candidates for director for recommendation to the Board. With respect to the current nominees for election as directors, Sven Murmann was the non-independent nominee recommended by Sauer Holding GmbH and Niels B. Christiansen, Jørgen M. Clausen, Kim Fausing, William E. Hoover, Jr., Frederik Lotz, and Sven Ruder were the non-independent nominees

II-9



recommended by Danfoss. Johannes F. Kirchhoff was the independent nominee recommended by Sauer Holding GmbH, and F. Joseph Loughrey and Steven H. Wood were the independent nominees recommended by Danfoss.

Stockholder Communications with the Board

        The Corporate Governance Guidelines of the Company set forth the method by which stockholders may communicate with the Board. Stockholders and other parties interested in communicating directly with the Chairman of the Board or with the non-management directors as a group or with the entire Board of Directors as a group or with an individual director may do so in writing addressed to such person or group at: Sauer-Danfoss Inc., 2800 East 13th Street, Ames, Iowa 50010, Attn: Corporate Secretary. The Corporate Secretary reviews all such correspondence and forwards all correspondence not deemed frivolous, threatening or otherwise inappropriate to each member of the group or to the individual director to whom the correspondence is directed. The Corporate Secretary shall maintain a log of all correspondence received by the Company that is addressed to members of the Board. Directors may at any time review such log and request copies of any such correspondence. Letters containing concerns relating to accounting, internal controls or auditing matters will immediately be brought to the attention of the Company's Internal Corporate Counsel and handled in accordance with procedures established by the Audit Committee with respect to such matters.

Code of Conduct and Code of Ethics

        The Company's Worldwide Code of Legal and Ethical Business Conduct (the "Code of Conduct") has been in effect for a number of years and was last updated on January 1, 2007. The Code of Conduct applies to every employee, agent, representative, consultant and director of the Company. The Code of Conduct requires that the Company's employees, agents, representatives, consultants and directors avoid conflicts of interest, comply with all laws and other legal requirements, conduct business in an honest and ethical manner and otherwise act with integrity and in the Company's best interests.

        Overall administration of the Code of Conduct is the responsibility of the Audit Committee. Day-to-day administration of the Code of Conduct is the responsibility of the Corporate Business Conduct Committee that assists the Company's employees in complying with the requirements of the Code of Conduct. Employees are encouraged to report any conduct that they believe in good faith to be an actual or apparent violation of the Code of Conduct.

        The Company has also adopted the Sauer-Danfoss Inc. Code of Ethics for Chief Executive Officer, Chief Financial Officer, Principal Accounting Officer or Controller and Other Senior Finance Staff (the "Code of Ethics"). The Code of Ethics is intended to comply with the provisions of Section 406 of the Sarbanes-Oxley Act of 2002 and regulations of the SEC. The Code of Ethics is intended to promote honesty and integrity, the avoidance of conflicts of interests, full, accurate, and timely disclosure of financial reports, and compliance with laws and regulations and other matters.

        The Code of Conduct and the Code of Ethics are posted on the Company's investor relations website at http://ir.sauer-danfoss.com. The Company will mail without charge, upon written request, a copy of the Code of Conduct and/or Code of Ethics. Requests should be sent to Kenneth D. McCuskey, Corporate Secretary at 2800 East 13th Street, Ames, Iowa 50010.

Transactions with Related Persons

        In connection with the acquisition of Danfoss Fluid Power on May 3, 2000, the Company entered into several agreements with Danfoss A/S to purchase ongoing operational services from Danfoss A/S. These services include rental of shared facilities, administrative support and information technology support. Fees are paid on a monthly basis. Total expense recognized for goods and services purchased from Danfoss A/S for 2008 was approximately $87.1 million. The Company also sold products to Danfoss A/S

II-10



totaling approximately $6.8 million in 2008. Danfoss A/S is the beneficial owner of more than 5% of the outstanding common stock of the Company.

        The Company entered into an Agreement for Transfer of Business and Sale of Inventory in 2008 (the "Agreement") with Danfoss LLC, a subsidiary of Danfoss A/S. The Agreement replaced a Distribution and Service Agreement which had been in place with Danfoss A/S under which the Company's products had been sold in the Commonwealth of Independent States. The Company purchased primarily customer relationships and inventory in this transaction.

        On March 12, 2009 the Company entered into a Credit Agreement with Danfoss A/S, which provides for a multicurrency term loan and revolving credit facilities of $490 million (the "Danfoss Credit Agreement") through September 30, 2010. Borrowings under the Danfoss Credit Agreement bear interest at an underlying funding rate (initially, LIBOR) plus 8.0%. The Company paid an upfront facility fee of 1.75% of the $490 million facility and will pay an annual commitment fee of 4% of any undrawn portion of the facility.

        In December 2008 the Company entered into a credit agreement with Danfoss A/S that provided for a $50 million term loan to the Company. The Company used the proceeds of the term loan to pay down other indebtedness that bore interest at a higher rate than the Company's rate under the term loan from Danfoss A/S. The term loan has a maturity date of December 9, 2011 and bears interest at an annual rate of 4.02%. The Company paid a facility fee of 10 basis points.

        To facilitate the redemption of the Company's outstanding U.S. 2000 Senior Notes in the principal amount of $24 million, the Company entered into an additional short-term $25 million loan agreement with Danfoss A/S on March 12, 2009. The loan bore interest at an annual rate of 3.98%, and matured on March 25, 2009. On March 25, 2009, the Company repaid the entire principal amount and $33,167 of accrued interest to retire the loan.

        The Company purchases inventory components from Shanghai Hydraulics and Pneumatics, a minority interest owner in an entity included in the Company's consolidated financial statements. The Company's cost for such purchases in 2008 was approximately $5.6 million.

        In addition, the Company sold product totaling approximately $4.1 million in 2008 to Daikin Industries Ltd. ("Daikin"), a minority interest owner in an entity consolidated by the Company. The Company also purchases inventory components and ongoing operational services from Daikin. The Company's cost for goods and services purchased from Daikin in 2008 was approximately $6.5 million.

        For a number of years, the Company has sold products to FAUN Umwelttechnik GmbH & Co. KG, which is owned by Johannes F. Kirchhoff, a director of the Company, and members of his family. These sales are made pursuant to purchase orders entered into in the ordinary course of business. Sales in 2008 totaled approximately $1.0 million.

Review, Approval or Ratification of Transactions with Related Persons

        The Company has a written policy pursuant to which the Company informs all of its directors and executive officers, as well as other personnel who serve in positions that give them routine knowledge of potential transactions with related persons, that they must inform specified individuals in management of transactions that meet the definitions provided in Item 404(a) of Regulation S-K ("related-person transactions"). Potential related-person transactions are reviewed by the Company's Audit Committee, which has the authority to approve or deny any such transaction. At least once per quarter, the Company's Secretary inquires of the individuals designated to receive reports of potential related-person transactions and relays any previously unreported transactions to the Audit Committee.

II-11



REPORT OF THE AUDIT COMMITTEE

        The Audit Committee of the Board of Directors (the "Board") of Sauer-Danfoss Inc. (the "Corporation") acts under the Sauer-Danfoss Inc. Audit Committee Charter, as amended and restated by the Board on March 18, 2009, which Charter provides that the purpose of the Audit Committee is to represent and assist the Board with the oversight of:

    the accounting, reporting and financial practices of the Corporation and its subsidiaries, including the integrity of the Corporation's financial statements;

    the functioning of the Corporation's systems of internal accounting and financial controls;

    the independent registered public accounting firm's qualifications and independence;

    the performance of the Corporation's internal audit functions and the independent registered public accounting firm;

    the Corporation's compliance with legal and regulatory requirements, and its ethics programs as established by management and the Board, including the Corporation's Worldwide Code of Legal and Ethical Business Conduct and any separate ethics code that relates to the integrity of the Corporation's financial reporting or applies to the Chief Executive Officer, Chief Financial Officer, or other senior financial officers.

        Management has the primary responsibility for the Corporation's financial statements and the financial reporting process, including the system of internal controls. The full text of the Audit Committee Charter is available under the Corporate Governance section of the Corporation's investor relations website at http://ir.sauer-danfoss.com.

        In fulfilling its oversight responsibilities, the Audit Committee has discussed with KPMG LLP ("KPMG"), the Corporation's independent registered public accounting firm, the overall scope and plans for their audit. The Audit Committee met with both management and KPMG to review and discuss the audited financial statements.

        The Audit Committee reviewed with KPMG their judgments as to the quality and acceptability of the Corporation's accounting principles. The Audit Committee's review included discussion with KPMG of the matters required to be discussed pursuant to Statement on Auditing Standards No. 114, as amended (which superseded Statement on Auditing Standards No. 61), as adopted by the Public Company Accounting Oversight Board in Rule 3200T.

        The Audit Committee has received and reviewed the written disclosures and the letter from KPMG required by the Independence Standards Board, Standard No. 1, "Independence Discussions With Audit Committees," as adopted by the Public Company Accounting Oversight Board in Rule 3600T, and has discussed with KPMG, among other things, matters relating to its independence. The Audit Committee has also considered the compatibility of the non-audit services provided by KPMG with its independence.

        Based on the reviews and discussions referred to above, the Audit Committee recommends to the Board of Directors that the audited financial statements for the year ended December 31, 2008 be included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2008, for filing with the Securities and Exchange Commission.

    Members of the Audit Committee:

 

 

Steven H. Wood, Chairman
Johannes F. Kirchhoff
F. Joseph Loughrey

March 17, 2009

 

 

II-12



EXECUTIVE COMPENSATION

COMPENSATION DISCUSSION AND ANALYSIS

        Sauer-Danfoss Inc. (the "Company" or "we") presents this Compensation Discussion and Analysis ("CD&A") to discuss its executive compensation program. Our Chief Executive Officer (the "CEO"), Chief Financial Officer (the "CFO") and other executive officers participate in the executive compensation program.

        The Summary Compensation Table on page II-26 and the subsequent disclosure tables reflect compensation paid to our CEO, CFO and to certain other executive officers (collectively, the "Named Executive Officers" or "NEOs"). In general, this CD&A discussion applies equally to each of the NEOs. Where needed for clarification, we have provided information on the treatment of individual NEOs.

        Under SEC rules, we are reporting information in the Summary Compensation Table for Mr. Anderson as CEO, for Mr. Schmidt as CFO and for Messrs. Cornett, Kittel and Schramm as the three most highly compensated executive officers of the Company, other than the CEO and CFO.

Role of Compensation Committee and Management in Executive Compensation Matters

        The Compensation Committee of our Board of Directors (the "Committee") consists of three independent directors as defined by current New York Stock Exchange listing standards. The Committee has the final say and ultimate authority in all matters relating to our executive compensation program. The Committee's authority encompasses areas such as:

    The overall design of our executive compensation program

    The determination of individual compensation elements and amounts for specific executives

    The determination of incentive compensation performance measures and targets

        From time to time, the Committee uses Hewitt Associates, LLP ("Hewitt") as its consultant with respect to executive compensation matters. At the request of the Committee in 2008, Hewitt performed a market-based review of certain executive compensation elements, as detailed later in the CD&A section entitled "Hewitt Market Review—2008". Hewitt also provided historical return on net assets results for a broad range of industrial companies to assist the Committee in developing performance targets under the Company's long-term incentive plan. Hewitt also provided the Committee with an update on current marketplace trends with respect to executive compensation practices. Hewitt's sole consulting relationship with the Company is related to the work done directly for the Committee.

        Management's role with respect to executive compensation matters is limited to making recommendations to the Committee, based on Management's understanding of the Company's compensation and performance objectives. Management's recommendations to the Committee include the CEO's annual performance evaluations of the other executive officers along with the CEO's recommendation for annual base salary changes for each such officer based on individual performance and market comparisons. The Committee considers Management's input and recommendations, but exercises independent judgment in making final decisions with respect to all matters affecting our executive compensation program.

Executive Compensation Goals and Objectives

        The Sauer-Danfoss Total Rewards Strategy, adopted and approved by the Committee in 2007 and reviewed annually, provides a general framework for Total Rewards offerings to all employees on a global basis.

II-13


        Our executive compensation program fits within our Total Rewards Strategy and is designed to meet certain goals and objectives. Specifically, we designed our executive compensation program to enable us to:

    Attract, motivate and retain quality leaders

    Promote teamwork and cooperation on a global basis

    Tie executive compensation levels to changes in shareholder value

    Tie executive compensation levels to business results

    Preserve the tax deductibility of our executive compensation

        We design our executive compensation program to reward performance. Within the program, we combine individual, business unit, division and company-wide performance elements. For our senior executives and Named Executive Officers, company-wide performance elements generally have the greatest impact on total compensation. We stress company-wide performance elements for the Named Executive Officers because they have the greatest impact on shareholder value creation. Company-wide performance elements also help us to promote global teamwork and cooperation among business units and divisions.

        The following table compares our Named Executive Officers' base salary plus earned incentives for 2008 to their respective base salary plus target incentive opportunities for 2008. The resulting percentage earned vs. target shows how the Company's performance against established performance targets impacts our executive officers' total compensation levels.

    For the Base Salary Plus Earned Incentives column, the 2006 Long-Term Incentive Award is included by multiplying the target number of performance units by the actual payout percentage of 37.5% and by the December 31, 2008 share price of $8.75. For the Base Salary Plus Target Incentives column, the 2006 Long-Term Incentive Award is included by multiplying the target number of performance units by the grant date share price of $25.93.

    For the Base Salary Plus Earned Incentives column, the 2008 Annual Incentive Award is included by multiplying the target award by the earned payout percentage of 0%. For the Base Salary Plus Target Incentives column, the 2008 Annual Incentive Award is included assuming a 100% of target payout.

    The table below reflects only base salary plus incentive compensation opportunities. Certain other compensation items, including post-employment compensation, pension costs, automobile costs and relocation costs, are excluded from this analysis.

    Mr. Anderson's 2007 and 2008 Long-Term Incentive Awards are excluded from this analysis as they were paid out at target upon his retirement and were, therefore, not performance-based. Mr. Schramm's restricted shares are excluded from this analysis as they vest based on length of service and are not performance-based.
 
  Base Salary
Plus Earned
Incentives
  Base Salary
Plus Target
Incentives
  Percentage
Earned vs.
Target
 

David J. Anderson

    770,459     2,195,322     35.1 %

Karl J. Schmidt

    390,785     1,025,390     38.1 %

Hans J. Cornett

    410,507     1,042,393     39.4 %

Thomas K. Kittel

    445,296     936,314     47.6 %

Wolfgang Schramm

    311,908     497,446     62.7 %

        We design our executive compensation program to be market-based. Based on a review of survey data from a variety of external sources, we believe our executive compensation program is comparable to, and

II-14



competitive with, the market median of compensation programs for similarly sized companies in similar industries. In comparing our executive compensation program to market, we consider such items as the balance between fixed and variable compensation and the annual and long-term incentive target opportunities. In our market comparisons, we generally look to survey data related to durable goods manufacturing companies with comparable revenue size.

        We also consider internal equity in the administration of our executive compensation program. Periodically, we perform a formal job evaluation process for all executive positions, rating them on a point-factor basis. We then use the position ratings to help ensure that our executive compensation program is aligned for comparable positions on a global basis.

        The Committee routinely reviews our executive compensation program and its individual elements in light of the goals and objectives outlined above.

Hewitt Market Review—2008

        In 2008, the Committee engaged Hewitt to perform a market-based review of executive officer base salaries and incentive compensation awards. As part of its review, Hewitt provided market data on base salaries and target opportunities, expressed as a percentage of base salary, for annual incentive awards and the grant date value of long-term incentive awards. Hewitt's market data was based on its review of data for a comparator group of companies based on similar revenue size and industry (industrial manufacturing). Hewitt recommended and the Committee approved the comparator group which consisted of the following companies:

ACCO Brands Corporate   Dade Behring Inc.   Joy Global Inc.   The Stanley Works
AMSTED Industries Incorporated   Dal-Tile International Inc.   Kaman Corporation   Steelcase Inc.
Andersen Corporation   Edwards Lifesciences LLC   Kennametal Inc.   Tecumseh Products Company
Applied Industrial Technologies   Energizer Holdings Inc.   Martin Marietta Materials Inc.   Thomas & Betts Corporation
Ash Grove Cement   Federal Signal   Milacron Inc.   Tupperware Brands
Brady Corporation   Fleetwood Enterprises, Inc.   Olin Corporation   United Space Alliance
C. R. Bard, Inc.   Flowserve Corporation   OMNOVA Solutions Inc.   Valmont Industries Inc.
Cameron International Corporation   H. B. Fuller Company   Polaris Industries Inc.   W. L. Gore & Associates, Inc.
Chaparral Steel Company   Herman Miller Inc.   Revlon Inc.   Walter Industries Inc.
Church & Dwight Company, Inc.   Hubbell Incorporated   The Scotts Miracle-Gro Company   Waters Corporation
Curtiss-Wright Corporation   Jacuzzi Brands, Inc.   Sensient Technologies Corporation   Woodward Governor Company

        The comparator group presented above is generally the same used by Hewitt in its analysis of 2007 base salaries and incentive compensation targets, except where companies in the 2007 group are no longer in existence. The Committee considered the Hewitt market data, Company-provided market survey data, as well as individual and Company performance, in determining executive officer base salary and incentive plan target percentage levels.

Elements Of Executive Compensation Program

        Our executive compensation program is comprised of the following elements which are described in further detail below:

    Base Salary

    Annual Incentive Awards

    Long-Term Incentive Awards

    Retirement & Savings Plans

    Additional Cash Compensation and Perquisites

    Other Potential Post-Employment Compensation

II-15


Base Salary

        We provide a base salary to our CEO and executive officers. The Committee determines the base salary for the CEO and our executive officers each year based upon a variety of factors.

        A key factor in the Committee's determination of base salaries is a comparison to market data. In determining 2008 base salary levels, the Committee reviewed market survey information for similar positions in companies similar to ours in size and industry.

        We target our base salaries at the 50th percentile for similar positions within the comparator and/or market survey benchmark group. The following factors also impact base salary determinations and will cause the base salaries to differ from the 50th percentile target:

    The Board of Directors' annual performance evaluation of the CEO relative to established objectives

    The CEO's annual performance evaluations of the other executives relative to established objectives

    Individual experience and expertise

    Internal equity

        With one exception, the base salary of each of our Named Executive Officers for 2008 was within +/- 15% of the benchmark market median. The sole exception is the CEO's base salary, which was below the benchmark market median by approximately 20% in 2008.

        Base salaries are one of the most readily comparable elements of compensation between different companies. We consider maintaining adequate annual base salary levels to be critical to achieving the stated goal of attracting, motivating and retaining quality leaders. By considering individual performance ratings in the annual base salary review process, our strongest performing executive officers will generally receive the largest percentage increases in annual base salary each year. This helps us meet our goal of motivating quality leaders and strengthens the tie between executive compensation and business results.

Annual Incentive Awards

        We provide Annual Incentive Award opportunities to our CEO and executive officers under the Company's Omnibus Incentive Plan. For 2008, the Annual Incentive Awards were designed to pay out a target percentage of a participant's base salary based upon achievement of certain earnings before interest and taxes ("EBIT") margins on a Divisional, Business Unit, and/or Total Company basis. To promote teamwork and cooperation across Divisions and Business Units, the Named Executive Officers participate in the Annual Incentive Plan on a Total Company basis.

        Actual payouts under the Annual Incentive Awards can range from 25% to 200% of target, depending upon achieved EBIT margins. Below certain minimum EBIT margin thresholds, no payout will be made under the Annual Incentive Awards. The Committee determines the target percentage of each executive officer's base salary for Annual Incentive Award purposes based on a review of market survey information for similar positions in comparable companies and also based on internal equity.

II-16


        For 2008 the Annual Incentive Plan's target, threshold and maximum payouts, expressed as a percentage of base salary, for each of our Named Executive Officers was as follows:

 
  Threshold
Payout
Percentage
  Target
Payout
Percentage
  Maximum
Payout
Percentage
 

David J. Anderson

    22.5 %   90 %   180 %

Karl J. Schmidt

    15 %   60 %   120 %

Hans J. Cornett

    15 %   60 %   120 %

Thomas K. Kittel

    15 %   60 %   120 %

Wolfgang Schramm

    15 %   60 %   120 %

        The Committee reviews and approves the EBIT margin levels that are required to earn the target payout at the beginning of each year. These levels are generally tied to our annual operating budgets. Our annual budgeting process produces aggressive goals which are considered to have a reasonable chance of being met through strong operating performance. We use EBIT margin performance factors to encourage and reward profitability on a Total Company and/or Divisional or Business Unit basis.

        We have determined that the Annual Incentive Award EBIT margin targets and their basis for computation involve confidential financial information and that disclosure could result in competitive harm to the Company. Therefore, we have not disclosed these targets within this CD&A and proxy statement.

        The following table, which shows the five-year payout history under the Annual Incentive awards for our Total Company measure, provides an indication of the difficulty in meeting the performance goals.

Year
  Earned
Payout
As A
Percentage
Of Target
 

2008

    0 %

2007

    0 %

2006

    113 %

2005

    45 %

2004

    136 %

        Under the Omnibus Incentive Plan, the Committee reserves the discretion to reduce, but not increase, the final payouts to executive officers. During 2006, the Committee authorized final payouts based on the achieved sales growth and EBIT margin performance, without reduction. In 2007 and 2008, no annual incentive awards were earned by the Named Executive Officers because threshold EBIT margins were not attained.

        With a clear relationship between financial results and payouts, our Annual Incentive Awards program helps us link our executive officer compensation levels to achieved business results. As a market-based program, it also helps us attract, motivate and retain quality leaders. Finally, the design of the shareholder-approved Omnibus Incentive Plan and the Annual Incentive Awards made thereunder helps ensure the tax deductibility of the Annual Incentive Awards earned in 2006.

Long-Term Incentive Awards

        We provide Long-Term Incentive Awards to our CEO and executive officers. The Omnibus Incentive Plan sets forth the terms and conditions under which our Long-Term Incentive Awards are made. The Company's established practice is to make Long-Term Incentive Award grants once each year, at the time of its regularly scheduled first quarter Compensation Committee meeting. The Omnibus Incentive Plan allows for a variety of forms of Long-Term Incentive Awards (e.g., Stock Options, Performance Units,

II-17



Restricted Stock). The Omnibus Incentive Plan also provides for a variety of performance measures for performance-based Long-Term Incentive Awards (e.g., Return on Sales, Return on Net Assets, Total Shareholder Return).

        In 2008, consistent with past practice, the Committee determined that the Long-Term Incentive Awards would be made 100% in the form of Performance Units. In addition, the Committee determined that average Return on Net Assets (RONA) over a three-year performance period would be the performance measure used for the Long-Term Incentive Awards. The three-year performance period promotes performance over a reasonable timeframe and builds an employee retention component into the Long-Term Incentive Awards.

        We use RONA as the performance measure because we view this metric over an extended period of time to be an important driver in shareholder value creation. The Committee set a three-year target for average RONA considering the Company's expected performance throughout the economic cycle and considering median RONA performance compiled by Hewitt for similarly sized companies in the Industrial Machinery sector.

        Beginning in 2007, a sales growth modifier was added to the Long-Term Incentive Plan's performance targets to encourage long-term growth in addition to profitability. Depending upon the average sales growth over the three-year performance period, the earned payout under the 2008 performance unit grant can be increased by up to 20%.

        Actual payouts under the 2008 Long-Term Incentive Award grants can range from 46% to 156% of target, depending upon achieved average RONA and sales growth over the three-year performance period. Below certain minimum average RONA thresholds, no payout will be made under the Long-Term Incentive Awards.

        The RONA thresholds, targets and maximums, along with the corresponding payout levels, are as follows:

 
  Grant
Year
  Threshold   Target   Maximum  

RONA Targets

    2008     10 %   14 %   16 %

    2007     10 %   14 %   16 %

    2006     8 %   14 %   16 %

Performance Unit Payout %

   
2008
   
46

%
 
90

%
 
130

%**

    2007     46 %   90 %   130 %**

    2006     25 %   100 %   200 %

**
For the 2007 and 2008 grant years, the earned payout based on RONA performance may be increased by a sales growth modifier of 10% to 20% depending upon the Company's average sales growth over the three-year performance period. The 10% and 20% sales growth modifiers result from three-year average sales growth of 5% and 15%, respectively. Between 5% and 15% sales growth, the modifier increases on a linear basis. With the sales growth modifier, the maximum payout under the 2007 and 2008 performance unit grants is 156% (130% × 120% sales growth modifier)

        The Committee determines the target percentage of a participant's base salary for Long-Term Incentive Award purposes each year, without consideration of prior awards, based on a review of market survey information for similar positions in comparable companies and based on internal equity.

        For 2008 the Long-Term Incentive Plan target award level, expressed as a percentage of adjusted base salary, for each of our Named Executive Officers was 125%. Adjusted base salary for this purpose equals the beginning of the year base salary plus 3%, as an approximation for the full-year base salary after merit pay increases which occur in April.

II-18


        The target number of performance units granted to each participant is determined by dividing the dollar value of the participant's Long-Term Incentive target by the average closing price of the Company's shares during the fourth quarter of the preceding year.

        For example, Mr. Anderson's target award opportunity under the 2008-2010 performance cycle was 31,421 performance units, determined as follows:

      # performance units = Base Salary × 103% × Target % / 2007 4th Quarter Avg Share Price
      # performance units = $615,000 × 103% × 125% / $25.20
      # performance units = 31,421

        Dividend equivalents on outstanding Performance Units are paid at the same time and at the same rate as dividends declared by the Company's Board of Directors on its common stock. During the performance period, the dividend equivalents are paid based on the target number of Performance Units held by each participant. By tying the payment of dividend equivalents into the Company's common stock dividends, the participants have incentive to focus on cash flow measures that drive shareholder value and returns.

        To promote share ownership, the Committee generally requires that earned Performance Units under the Long-Term Incentive Awards program be paid to participants 100% in shares of Company stock, with a number of shares withheld from the payout equal to the value needed to cover the Company's minimum statutory tax withholding requirements. By direction of the Committee, earned Performance Units from the 2008 Performance Unit grant for Mr. Kittel are to be paid out 100% in cash. At the time of making the 2008 grant, the Committee determined that Mr. Kittel had significant levels of Company stock ownership, at approximately 10 times his annual base salary.

        The Performance Unit Award Agreements generally provide for automatic forfeiture upon a termination from service prior to the end of the performance period and/or the payout date. The Performance Unit Award Agreements generally provide for pro-rata, post-employment payouts of earned Performance Units under the following situations:

    Retirement at full, normal retirement age

    Death

        The Long-Term Incentive Awards are subject to immediate vesting and payout, at the target level, upon a Change In Control of the Company, as defined in the Omnibus Incentive Plan. As discussed later in this CD&A, Mr. Anderson's Long-Term Incentive Awards granted in 2007 and 2008 were subject to immediate vesting and payout at target levels upon his retirement on December 31, 2008.

        Under the Omnibus Incentive Plan, the Company has the right to seek a reimbursement of amounts previously paid to any Participant who engaged in misconduct or was aware of and failed to report misconduct when such misconduct leads to a restatement of financial earnings. The Company also has certain automatic forfeiture rights under Section 304 of the Sarbanes-Oxley Act of 2002.

        The 2006 Performance Unit grants were subject to a three-year performance period and provided for a payout from 25% to 200% of the target number of Performance Units granted. Based on achieved average RONA performance of 9.0% for the three-year period ended December 31, 2008, the 2006 Performance Units were paid out at 37.5% upon completion of the Company's financial audit in March 2009. Generally, each earned Performance Unit equates to one share of Sauer-Danfoss Inc. stock. An

II-19



analysis of the target number of Performance Units granted, along with actual earned Performance Units for each of the Named Executive Officers, is as follows:

 
  Target #
Performance
Units
  Payout
Percentage
  Earned
Performance
Units
 

David J. Anderson

    37,403     37.5 %   14,026  

Karl J. Schmidt

    19,430     37.5 %   7,286  

Hans J. Cornett

    18,459     37.5 %   6,922  

Thomas K. Kittel

    10,824     37.5 %   4,059  

Wolfgang Schramm

    0     37.5 %   0  

        The value of payouts stemming from the Earned Performance Units reflected above can be found in the Outstanding Equity Awards At Fiscal Year-End Table appearing later in this proxy statement.

        At the time of his hiring in April 2007, Mr. Schramm was granted 10,000 shares of restricted stock under the Company's Omnibus Incentive Plan. 5,000 restricted shares vested on his one-year service anniversary (April 2008) and the remaining 5,000 restricted shares vested on his two-year service anniversary (April 2009). The restricted share issuance to Mr. Schramm served as a recruiting measure and as a short-term retention measure. The restricted share issuance bridges the period from Mr. Schramm's hire date until he would be eligible to receive any earned payouts under the Company's 2007 Performance Unit Award Agreement at the end of calendar year 2009.

        With a clear relationship between financial results and payouts, our Long-Term Incentive Awards program helps us tie our executive compensation levels to achieved business results. As an equity-based program, it also ties our executive compensation levels into returns earned by our shareholders. As a market-based program, it also helps us attract, motivate and retain quality leaders. Finally, the design of the shareholder-approved Omnibus Incentive Plan and Long-Term Incentive Awards granted thereunder helps ensure the tax deductibility of Long-Term Incentive Awards ultimately paid out.

Retirement & Savings Plans

        The Retirement & Savings Plans in which our executive officers participate consist of the following:

    Local Pension and/or 401(k) Savings Plans

    Supplemental Retirement and/or Savings Plans

    Elective Deferred Compensation Plans for Cash Compensation

    Elective Deferred Compensation Plans for Long-Term Incentive Compensation

        Our Local Pension and/or 401(k) Savings Plans are made available to all eligible employees, including the Named Executive Officers, and vary by country. Our Named Executive Officers generally participate in their country-specific Local Pension and/or 401(k) Savings Plans on the same terms and conditions made available to all other participants in the respective plans. Our Local Pension Plans are described in further detail in the Pension Benefits Table and narrative beginning on page II-32.

        Our Supplemental Retirement and/or Savings Plans are made available to those U.S. officers and employees whose annual compensation exceeds certain limits imposed by the IRS and whose retirement benefits under the Local Pension and/or 401(k) Savings Plans are limited as a result. The Supplemental Retirement and/or Savings Plans operate to replace the retirement benefits that would be lost as a result of the IRS limits. Messrs. Anderson, Schmidt, Cornett and Schramm participate in the Supplemental Retirement and/or Savings Plans.

        Our Local Pension and/or 401(k) Savings Plan benefits and our Supplemental Retirement and/or Savings Plan benefits are determined primarily by considering base salary. Payouts under the Annual

II-20



Incentive Plan Awards or the Long-Term Incentive Plan Awards generally do not impact the amount a participant will receive under these plans.

        The Elective Deferred Compensation Plans for Cash Compensation are made available to U.S. Vice Presidents and executive officers as a means to allow them to save, on a tax-deferred basis, all or a portion of their annual cash compensation (Base Salary and Annual Incentive Award). Deferred compensation under these plans represents an unfunded, unsecured liability of the Company. During the deferral period, participants' deferred compensation accounts are credited with a variable earnings credit that is tied to ten-year U.S. treasury yields and a credit risk spread based on the Company's credit profile. Mr. Anderson has elected to participate in the Elective Deferred Compensation Plans for Cash Compensation.

        The Elective Deferred Compensation Plan for Long-Term Incentive Compensation has been made available to Messrs. Anderson, Schmidt and Cornett as a means to allow them to defer the receipt of their payouts under the Company's Long-Term Incentive Awards program. The determination of whether to extend the invitation to participate is made by the Committee on a grant-by-grant basis and depends, in part, on the Company's exposure to compensation deduction limitations under Internal Revenue Code Section 162(m). During the deferral period, the deferred compensation retains its original form (i.e., Performance Units). At the end of the deferral period, the deferred Performance Units are paid in the same form, shares or cash, as originally determined by the Committee. During the deferral period, dividend equivalents earned on the deferred Performance Units are also deferred and represent an unfunded, unsecured liability of the Company. During the deferral period, the deferred dividend equivalent accounts are credited with a variable earnings credit that is tied to ten-year U.S. treasury yields and a credit risk spread based on the Company's credit profile. Messrs. Anderson and Schmidt have elected to participate in the Elective Deferred Compensation Plan for Long-Term Incentive Compensation.

        Executives participating in the Elective Deferred Compensation Plan for Long-Term Incentive Compensation can experience adverse capital gains tax consequences if the Company's share value declines during the deferral period. A decline in share value during the deferral period causes the net shares received by the participant, after payroll tax withholding, to have a lower tax basis. A later sale of these lower tax basis shares results in a greater capital gain or lower taxable loss than would have resulted had the shares not been deferred. The Committee has agreed to make a capital gains tax protection payment to participants if their deferred Performance Units are paid out at a time when the shares are lower in value than on the date when the Performance Units would have originally been paid, based on a fixed formula. As of December 31, 2008, the potential tax basis protection payouts to Messrs. Anderson and Schmidt would total $87,825 and $133,033, respectively, based on the December 31, 2008 closing share price of $8.75. The actual tax basis protection payouts, if any, will depend upon the share price on the date that deferred performance units are paid out.

        The Supplemental Retirement and/or Savings Plans and the Elective Deferred Compensation Plans are described in further detail in the Nonqualified Deferred Compensation Table and narrative beginning on page II-34.

        Based on observed market practices, we believe our Retirement & Savings Plans are comparable to those found in the marketplace for senior executives. These plans help us attract, motivate and retain quality leaders. In addition, the elective deferred compensation programs can help ensure the corporate tax deductibility of compensation in years when an executive's compensation might otherwise exceed the tax deductible compensation limits of Internal Revenue Code Section 162(m).

II-21


Additional Cash Compensation and Perquisites

        We provide a few additional elements of cash compensation and/or perquisites to our executives. These elements include:

    Relocation Stipend and/or Relocation Expenses

    Automobile Allowances and/or Company Cars

    Paid Time Off (PTO) Sell Back

    Spousal Travel

        The relocation stipend paid to Messrs. Anderson, Schmidt and Cornett was put in place at the time they relocated to our Lincolnshire, Illinois office. The Compensation Committee determined that the executives should be given a stipend to assist them with the higher cost of housing in the Chicago area. The stipends have a limited term (60 months) and ended in August 2006 for Mr. Cornett, May 2007 for Mr. Anderson and August 2008 for Mr. Schmidt.

        During 2008, the Committee authorized Mr. Cornett to relocate his primary office from the Company's Lincolnshire, Illinois office to its Neumünster, Germany facility. Mr. Cornett received the Company's standard relocation assistance from the Company during 2008. The full cost of Mr. Cornett's relocation assistance, $34,864, has been included in the Other Compensation Column of the Summary Compensation Table.

        Upon his hiring date in 2007, the Committee authorized that Mr. Schramm move to the Company's Plymouth, Minnesota facility. Mr. Schramm received the Company's standard relocation assistance from the Company. The full cost of Mr. Schramm's relocation assistance, $32,349 in 2007 and $5,805 in 2008, has been included in the Other Compensation Column of the Summary Compensation Table. Also included in 2008 is an additional $40,000 that the Committee authorized for payment to Mr. Schramm in order to cover certain duplicate housing costs resulting from the soft U.S. real estate market.

        Automobile allowances are paid to Messrs. Anderson, Schmidt and Schramm in lieu of providing company cars for their use. Mr. Cornett received an automobile allowance during the period of his U.S. employment. As European-based officers, Mr. Kittel and Mr. Cornett are provided a company car for business and personal use. Automobile allowances or allowing the use of a company car are common in the market for senior executives and are used by us to attract, motivate and retain quality leaders.

        The Company's Paid Time Off (PTO) plan allows U.S. employees, including officers, to sell back up to 80 hours of paid time off (i.e. vacation) per year. This may be preferable for employees who are nearing their maximum PTO accrual and would otherwise begin to lose the value of their full PTO benefit. Mr. Schmidt utilized the PTO sell-back option in 2008. The resulting cash payment to him has been included in the Other Compensation Column of the Summary Compensation Table.

        Similarly, departing U.S. employees are able to receive a cash payout of their remaining PTO accrual balance upon their termination of employment. Mr. Anderson received such a payout after his retirement in December 2008. Mr. Cornett received a payout of his accrued U.S. PTO balance upon his transfer to Germany as his PTO eligibility will now be based on German PTO provisions. These cash payments have been included in the Other Compensation Column of the Summary Compensation Table.

        Due to a high frequency of international travel, we allow spouses to accompany executives on up to two international trips per year. The Company pays coach class airfare for any such spousal trips. The executive is responsible for any income taxes resulting from such Company-paid spousal trips.

II-22


Other Potential Post-Employment Compensation

        The Company has Employment Agreements in place with its executive officers, including all of the Named Executive Officers that provide the potential for post-employment compensation in certain instances (i.e., triggers). The triggers that would provide for post-employment compensation are as follows:

    Termination Due to Death or Disability

    Termination By The Company Without Cause

    Termination By The Executive With Good Reason

    Change in Control of the Company and Termination by the Company Without Cause or by the Executive With Good Reason Within Two Years following the Change in Control

        Based on observed market practices, the triggers identified above, which can lead to post-employment compensation, are comparable to those found in the marketplace for CEOs and other senior executives.

        The material terms of the Employment Agreements, including the provisions relating to potential post-employment compensation, are discussed in detail in the Potential Payments Upon Termination or Change in Control section beginning on page II-37.

Dave Anderson Retirement and Post-Employment Compensation

        In October 2008, Mr. Anderson announced his intention to retire from the Company, effective December 31, 2008. The Company and Mr. Anderson agreed that his retirement would be treated under the Termination Without Cause / Termination With Good Reason provisions of his employment agreement and his 2007 and 2008 Long-Term Incentive Award agreements. This treatment was in recognition of Mr. Anderson's support during the time leading up to the appointment of a successor and during the leadership transition.

        As a result of this treatment and pursuant to his employment and long-term incentive award agreements, Mr. Anderson was paid or provided the following amounts upon his retirement:

    $79,694—Accrued Paid Time Off at Termination Date

    $227,719—2007 Long-Term Incentive Award Target Payout In Cash

    $247,934—2008 Long-Term Incentive Award Target Payout in Shares

    $1,852,500—Separation Payment = 11/2 Times Base Salary & Annual Incentive Target

    Medical Plan Continuation At No Additional Cost For 12 Months

    Financial Planning Services—Up To $20,000 Value

        The accrued, paid time off and the separation payment listed above were paid to Mr. Anderson in 2009 and are included in the All Other Compensation column of the Summary Compensation Table on page II-26, as they were vested upon his December 31, 2008 retirement date.

        Upon his retirement Mr. Anderson also became entitled to receive his previously vested, non-qualified retirement benefit under the Company's Supplemental Retirement Benefit Plan. The total benefit, projected to be approximately $1.8 million, will be paid in a lump sum payment in January 2010. The lump sum benefit payable to Mr. Anderson for his non-qualified retirement benefit is computed using the same age and interest rate discount factors that apply to the Company's qualified retirement plan.

New CEO Hiring & Compensation Elements

        In October 2008, the Company announced its intention to hire Sven Ruder as its President and CEO, effective on January 1, 2009. Mr. Ruder has made his primary office at the Company's Neumünster,

II-23



Germany facility. The Committee reviewed and approved Mr. Ruder's compensation package, including the following primary elements:

    450,000 Euro Base Salary

    60% Annual Incentive Plan Target

    125% Long-Term Incentive Plan Target

2009 Actions In Response To Economic & Market Downturn

        The general economic climate entering 2009 is having a significant impact on the Company and our markets. In response to the economic and market climate, Mr. Ruder proposed the following actions, which were approved by the Committee in a February 2009 teleconference meeting:

    15% base salary reduction for the CEO, effective March 1, 2009

    10% base salary reduction for the Executive Officers and Vice Presidents, effective March 1, 2009

    Suspension of the Annual Incentive Award program for 2009

    Suspension of the Long-Term Incentive Award program for 2009

        While these actions will temporarily diminish our ability to fulfill some of the executive compensation objectives stated earlier, we believe they are an appropriate and necessary response to the current climate.

Stock Ownership Guidelines

        The Company has no formal stock ownership guidelines due, in part, to the closely-held nature of the Company. The Committee strongly encourages share ownership among the senior executives and monitors such share ownership on an annual basis.

Financial Accounting and Tax Impacts of Executive Compensation Program

        Internal Revenue Code ("IRC") Section 162(m) limits U.S. and state tax deductions for compensation in excess of $1,000,000 paid to the CEO and to the other Named Executive Officers during any taxable year.

        The Company's Omnibus Incentive Plan has been designed to meet the qualifying criteria for the performance-based compensation exception to IRC Section 162(m). Incentive awards granted under the Omnibus Incentive Plan are designed to be fully deductible for U.S. and state tax purposes.

        The cash-based elements of our executive compensation program, including Base Salary and Annual Incentive Awards, are treated as a financial statement expense in the year incurred. The Long-Term Incentive Awards are accounted for pursuant to the Rules of Financial Accounting Standard 123R with financial statement expense recognized over the three-year performance period.

Compensation Committee Interlocks and Insider Participation

        The Committee's members during 2008 were Johannes F. Kirchhoff, F. Joseph Loughrey, and Steven H. Wood, none of whom is or has ever been an officer or employee of the Company. Johannes F. Kirchhoff and members of his family are owners of FAUN Umwelttechnik GmbH & Co. KG, which purchased products from the Company in 2008 for an aggregate purchase price of approximately $1.0 million.

II-24


Compensation Committee Report

        The information contained in the following report shall not be deemed to be "soliciting material" or "filed" or incorporated by reference in future filings with the Securities and Exchange Commission, or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference into a document filed under the Securities Act of 1933 or the Securities Exchange Act of 1934.

        The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis (CD&A) with management and, based on the review and discussion, has recommended to the Board that the CD&A be included in the Company's Proxy Statement and be incorporated by reference into the Company's Annual Report on Form 10-K for the year ended December 31, 2008, as filed with the Securities and Exchange Commission.

                        COMPENSATION COMMITTEE:

                        Johannes F. Kirchhoff, Chairman
                        F. Joseph Loughrey
                        Steven H. Wood

March 18, 2009

II-25



SUMMARY COMPENSATION TABLE

Name and Principal Position(a)
  Year
(b)
  Salary
($) (c)
  Stock
Awards
(2) ($) (e)
  Non-Equity
Incentive
Plan
Compensation
(3) ($) (g)
  Change in
Pension
Value and
Nonqualified
Deferred
Compensation
Earnings
(4) ($) (h)
  All Other
Compensation
(5) ($) (i)
  Total
($) (j)
 

David J. Anderson

    2008     647,731     287,544     0     742,199     1,995,629     3,673,103  
 

President & Chief

    2007     608,279     459,386     0     279,002     64,313     1,410,980  
 

Executive Officer

    2006     570,625     832,922     386,525     196,410     96,667     2,083,149  

Karl J. Schmidt

   
2008
   
327,032
   
(181,965

)
 
0
   
5,697
   
53,611
   
204,375
 
 

Executive Vice President &

    2007     313,038     303,763     0     5,528     45,832     668,161  
 

Chief Financial Officer

    2006     296,850     410,497     201,100     5,058     81,583     995,088  

Hans J. Cornett(1)

   
2008
   
349,939
   
(172,868

)
 
0
   
5,298
   
98,466
   
280,835
 
 

Executive Vice President &

    2007     301,942     283,714     0     5,623     36,275     627,554  
 

Chief Marketing Officer

    2006     277,387     372,294     187,672     5,158     64,496     907,007  

Thomas K. Kittel(1)

   
2008
   
409,780
   
(195,159

)
 
0
   
36,390
   
99,343
   
350,354
 
 

Executive Vice President &

    2007     341,979     177,531     0     0     49,760     569,270  
 

President Propel Division

    2006     281,360     249,614     136,098     39,696     39,575     746,343  

Wolfgang Schramm

   
2008
   
311,908
   
28,964
   
0
   
4,637
   
73,599
   
419,108
 
 

Executive Vice President &

    2007     214,615     216,565     0     1,154     50,670     483,004  
 

President Controls Division

                                           

Footnotes To Summary Compensation Table

(1)
Certain compensation items earned by Mr. Kittel and Mr. Cornett were valued in Euros and were converted to U.S. dollars for this table and all other tables using a weighted average annual exchange rate (USD/Euro) of 1.4635, 1.3673 and 1.2543 for 2008, 2007 and 2006, respectively.

(2)
These amounts represent the financial statement expense under FAS 123R of the Performance Units held by each Named Executive Officer. Further information concerning the Company's accounting for Performance Units under FAS 123R can be found in footnote number 13 to its consolidated financial statements filed as part of its Form 10-K for the year ended December 31, 2008.

(3)
Amounts shown for 2006 were earned based upon performance against specific performance criteria under the Annual Incentive Plan in 2006. No payouts were earned in 2007 or 2008 under the Annual Incentive Plan as the Company did not meet the threshold level of performance needed to earn a minimum payout.

II-26


(4)
These amounts represent the aggregate increase in the actuarial present value of all defined benefits and actuarial plans, including supplemental plans, accrued during the year plus above-market earnings on nonqualified deferred compensation, using 120% of the applicable federal long-term rate as the basis for market earnings. The amounts are detailed as follows:
 
Name
  Year   Change In
Value Of
German
Pension Plan
($)
  Change In
Value Of US
Qualified
Retirement
Plan
($)
  Change In
Value Of US
Non-Qualified
Retirement
Plan
($)
  Above
Market
Earnings On
Non-Qualified
Deferred
Compensation
($)
  Total
($)
 
 

David J. Anderson

    2008     0     154,371     576,556     11,272     742,199  
 

    2007     0     74,763     191,923     12,316     279,002  
 

    2006     0     67,185     118,426     10,799     196,410  
 

Karl J. Schmidt

   
2008
   
0
   
5,411
   
0
   
286
   
5,697
 
 

    2007     0     5,504     0     24     5,528  
 

    2006     0     5,058     0     0     5,058  
 

Hans J. Cornett

   
2008
   
0
   
5,298
   
0
   
0
   
5,298
 
 

    2007     0     5,623     0     0     5,623  
 

    2006     0     5,158     0     0     5,158  
 

Thomas K. Kittel

   
2008
   
36,390
   
0
   
0
   
0
   
36,390
 
 

    2007     0     0     0     0     0  
 

    2006     39,696     0     0     0     39,696  
 

Wolfgang Schramm

   
2008
   
0
   
4,637
   
0
   
0
   
4,637
 
 

    2007     0     1,154     0     0     1,154  

The 2008 increase in the value of Mr. Anderson's Non-Qualified Retirement Plan benefit stems from the vesting in this benefit upon his retirement on December 31, 2008. Upon vesting, certain actuarial reduction factors were no longer applicable.
The actuarial present value of Mr. Kittel's German pension plan benefit declined by $27,511 in 2007, due to a 1% increase in the discount rate used to determine the present value. In accordance with SEC disclosure rules, the Company is not reporting this decrease in the Summary Compensation Table.

(5)
The All Other Compensation amounts represent the following amounts and are explained in greater detail in the Additional Cash Compensation and Perquisites section of the CD&A:
Name
  Year   Dividend
Equivalents
Paid On
Outstanding
Performance
Units
($)
  Relocation
Stipend
or
Relocation
Costs
($)
  Auto
Allowance
($)
  Company
Car
($)
  PTO Sellback
PTO Payout
  Post-
Employment
Compensation
($)
  Company
Contributions
To 401(k)
Plan and to
Supplemental
Retirement
Plans
($)
  Other
Perquisites
($)
  Total
($)
 

David J. Anderson

    2008     45,668     0     12,720     0     79,694     1,852,500     0     5,047     1,995,629  

    2007     45,668     5,625     12,720     0     0     0     0     300     64,313  

    2006     68,748     13,500     12,720     0     0     0     0     1,699     96,667  

Karl J. Schmidt

   
2008
   
0
   
12,613
   
12,720
   
0
   
6,288
   
0
   
14,854
   
7,136
   
53,611
 

    2007     0     18,920     12,720     0     0     0     14,192     0     45,832  

    2006     36,547     18,920     12,720     0     0     0     13,396     0     81,583  

Hans J. Cornett

   
2008
   
0
   
34,864
   
9,540
   
10,267
   
24,195
   
0
   
14,870
   
4,730
   
98,466
 

    2007     0     0     12,720     0     9,385     0     13,523     647     36,275  

    2006     33,091     4,800     12,720     0     0     0     12,208     1,677     64,496  

Thomas K. Kittel

   
2008
   
32,374
   
0
   
0
   
28,400
   
0
   
0
   
32,692
   
5,877
   
99,343
 

    2007     17,896     0     0     22,667     0     0     6,814     2,383     49,760  

    2006     20,851     0     0     16,632     0     0     0     2,092     39,575  

Wolfgang Schramm

   
2008
   
0
   
45,805
   
12,750
   
0
   
0
   
0
   
13,954
   
1,090
   
73,599
 

    2007     0     32,349     9,563     0     0     0     2,308     6,450     50,670  

    For 2006, the dividend equivalents on all outstanding Performance Units were expensed by the Company as paid and are therefore reflected in the dividend equivalents column above. Beginning in 2007 for Performance Units to be paid in shares, the value of future dividend equivalents is included in the grant date fair market value for FAS 123R reporting and is, therefore, reflected in the Stock Awards column of the Summary Compensation Table. Continuing in 2007 and 2008 for Performance Units to be paid out in cash to Messrs. Anderson and Kittel, the dividend equivalents are expensed as paid and reflected in the dividend equivalents column above.

    The values of Mr. Kittel's and Mr. Cornett's company cars are based on the annual operating costs to the Company. Other perquisites include spousal travel, airline club fees and insurance premiums.

II-27



GRANTS OF PLAN-BASED AWARDS TABLE

 
   
  Estimated Possible Payouts
Under Non-Equity
Incentive Plan Awards(2)
  Estimated Future Payouts
Under Equity
Incentive Plan Awards
   
 
 
   
  Grant Date
Fair Value of
Stock and
Option
Awards(1)(l)
 
Name(a)
  Grant Date(1)(b)   Threshold
($)(c)
  Target
($)(d)
  Maximum
($)(e)
  Threshold
(#)(f)
  Target
(#)(g)
  Maximum
(#)(h)
 

David J. Anderson(3)

  March 12, 2008                       14,454     31,421     49,017     593,543  

David J. Anderson

  March 12, 2008     144,433     577,731     1,155,462                          

Karl J. Schmidt

 
March 12, 2008
                     
7,403
   
16,094
   
25,107
   
304,016
 

Karl J. Schmidt

  March 12, 2008     48,635     194,538     389,076                          

Hans J. Cornett

 
March 12, 2008
                     
7,168
   
15,583
   
24,309
   
294,363
 

Hans J. Cornett

  March 12, 2008     53,453     213,812     427,624                          

Thomas K. Kittel

 
March 12, 2008
                     
9,250
   
20,108
   
31,368
   
379,840
 

Thomas K. Kittel

  March 12, 2008     61,467     245,868     491,736                          

Wolfgang Schramm

 
March 12, 2008
                     
7,050
   
15,327
   
23,910
   
289,527
 

Wolfgang Schramm

  March 12, 2008     46,385     185,538     371,076                          

Footnotes to Grants of Plan-Based Awards Table

(1)
The award grants presented in the above table were made under the Company's Omnibus Incentive Plan. The Compensation Committee awarded these grants at its regularly scheduled meeting on March 12, 2008. The grant date fair value of the stock awards equals the target number of Performance Units or Restricted Shares multiplied by the Company's closing share price of $18.89 on March 12, 2008.

(2)
As reflected in the Summary Compensation Table, no payout was earned in 2008 from the Non-Equity Incentive Plan Awards as the Company did not meet the threshold level of performance under the 2008 Annual Incentive Plan.

(3)
Mr. Anderson became vested in the target number of Performance Units upon his retirement on December 31, 2008. Based on a December 31, 2008 share price of $8.75, the 31,421 Performance Units had a payout value of $274,934.

II-28



SUMMARY COMPENSATION AND GRANTS OF PLAN-BASED AWARDS NARRATIVE

        Each of the Named Executive Officers has an Employment Agreement with Sauer-Danfoss Inc. which details, among other things, the components of such officer's compensation. The Employment Agreements that were in effect for most of 2008 for the Named Executive Officers, other than Mr. Schramm, were entered into in December 2002 and were to continue in effect until termination of employment. Mr. Schramm's Employment Agreement was entered into on April 16, 2007 and contains a two-year term, automatically renewable for successive one-year terms in the absence of written notice by either party. The Employment Agreements for Messrs. Schmidt and Schramm were replaced, effective December 31, 2008 with agreements containing substantially similar terms and written to comply with IRC Section 409A. Mr. Cornett's Employment Agreement was replaced, effective September 1, 2008, and Mr. Kittel's Employment Agreement was replaced, effective January 1, 2009, with agreements containing substantially similar terms and written to comply with German employment law, due to the location of their primary offices in the Company's Neumünster, Germany facility.

        Rights of the officers to certain post-employment compensation under the terms of the Employment Agreements are discussed in the Potential Payments upon Termination or Change in Control section beginning on page II-37.

        The officer Employment Agreements provide for base salary levels, which increase under the Company's annual salary review process, as described in the CD&A. Once increased, the Employment Agreements provide that an officer's base salary cannot be decreased without the officer's consent, unless as part of a blanket decrease to the base salaries of all officers. As noted in the CD&A, a blanket decrease was made to the base salaries of all officers, effective March 1, 2009.

Stock Awards

        The Named Executive Officers have outstanding Performance Unit grants under the Company's Omnibus Incentive Plan. The target numbers of Performance Units and Restricted Shares outstanding are detailed later in the Outstanding Equity Awards At Fiscal Year-End Table.

        The performance unit award agreements call for the payout of Performance Units based on average Return on Net Asset (RONA) performance over a three-year performance period. The Performance Unit awards generally allow for a percentage payout of the target number of Units, depending upon RONA performance. Below established RONA thresholds, there is no payout under the Performance Unit awards. Beginning in 2007, a sales growth modifier was added to the performance measurements for purposes of determining earned Performance Unit payouts.

        The Performance Unit award agreements include forfeiture upon termination of service from the Company prior to payment, except terminations due to Retirement, Disability or Death, in which case pro-rated payouts will be made, based on final RONA performance. The Compensation Committee can make exceptions to the automatic forfeiture provisions, in its sole discretion.

        As noted in the CD&A, Mr. Anderson became vested in the target number of Performance Units from his 2007 and 2008 Performance Units upon his retirement on December 31, 2008. Mr. Anderson's vested 2007 Performance Units are payable in cash, based on the December 31, 2008 share closing price. Mr. Anderson's vested 2008 Performance Units are payable in shares of the Company.

        The performance unit award agreements also call for a payout, at target levels, of Performance Units in the event of a Change in Control of the Company, as defined in the agreements.

        By decision of the Compensation Committee, earned Performance Units are payable in shares of Company stock, with a number of shares withheld to cover the Company's minimum statutory tax withholding requirements. Earned Performance Units under the 2006, 2007 and 2008 award agreements

II-29



for Mr. Kittel are payable in cash, based on the Company's closing share price on December 31, 2008, December 31, 2009 and December 31, 2010, respectively.

        The performance unit awards allow for the payment of dividend equivalents, as declared by the Company's Board of Directors. The practice of the Board has been to authorize the payment of dividend equivalents, based on the number of target Performance Units held, at the same time and at the same rate as dividends declared on the Company's common stock.

Non-Equity Incentive Compensation

        The Non-Equity Incentive Compensation represents amounts granted to and earned by the Named Executive Officers under the Company's Annual Incentive Award program. The Annual Incentive Award program is performance-based and is tied to the Company's performance against pre-determined targets for Earnings Before Interest & Taxes (EBIT) margins.

        Annual Incentive Award payouts are based on a range of 25% to 200% of pre-established payout targets depending upon EBIT margin performance. Below certain minimum threshold EBIT margin levels, there is no payout under the Annual Incentive Award program.

        In 2008, base salary made up roughly 18% and 74% of the Total Compensation for Messrs. Anderson, and Schramm, respectively. Due to the negative amounts associated with outstanding equity awards, base salaries exceeded Total Compensation in 2008 for Messrs. Schmidt, Cornett and Kittel.

II-30



OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END TABLE

 
  Stock Awards  
Name (a)
  Number of Shares or
Units of Stock That
Have Not Vested
(#)(g)
  Market Value of
Shares or Units of
Stock That
Have Not Vested
($)(h)
  Equity Incentive Plan Awards:
Number of Unearned Shares,
Units or Other Rights
That Have Not Vested
(#)(i)
  Equity Incentive Plan Awards:
Market or Payout Value of
Unearned Shares,
Units or Other Rights
That Have Not Vested
($)(j)
 

David J. Anderson(1)

    14,026   $ 122,728              

David J. Anderson(2)

    26,025   $ 227,719              

David J. Anderson(3)

    31,421   $ 274,934              

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Karl J. Schmidt(1)

    7,286   $ 63,753              

Karl J. Schmidt(2)

                6,219   $ 54,416  

Karl J. Schmidt(3)

                7,403   $ 64,776  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hans J. Cornett(1)

    6,922   $ 60,568              

Hans J. Cornett(2)

                5,908   $ 51,695  

Hans J. Cornett(3)

                7,168   $ 62,720  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Thomas K. Kittel(1)

    4,059   $ 35,516              

Thomas K. Kittel(2)

                6,455   $ 56,481  

Thomas K. Kittel(3)

                9,250   $ 80,938  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wolfgang Schramm(2)

                6,038   $ 52,833  

Wolfgang Schramm(3)

                7,050   $ 61,688  

Wolfgang Schramm(4)

                5,000   $ 43,750  

Footnotes To Outstanding Equity Awards At Fiscal Year-End Table

(1)
2006 Performance Unit Awards granted on June 1, 2006, with a Performance Period from January 1, 2006 through December 31, 2008. Based upon achieved RONA performance and subject to Compensation Committee approval, the Named Executive Officers have earned a payout under these awards equal to 37.5% of target. These earned Performance Units fully vested on the payout date of March 25, 2009. The value reflected above is based on the closing share price of $8.75 as of December 31, 2008; actual value for Messrs. Schmidt and Cornett will be based on the closing share price as of March 24, 2009.

(2)
2007 Performance Unit Awards granted on March 20, 2007 (April 16, 2007 for Mr. Schramm), with a Performance Period from January 1, 2007 through December 31, 2009. These amounts represent the threshold number of units for each Named Executive Officer and the value of those units based on a per share value of $8.75 as of December 31, 2008. Actual earned Performance Units will fully vest on the payout date in February 2010. Mr. Anderson's units reflect the target number of units that vested upon his retirement on December 31, 2008 and that were paid in cash on January 9, 2009.

(3)
2008 Performance Unit Awards granted on March 12, 2008, with a Performance Period from January 1, 2008 through December 31, 2010. These amounts represent the threshold number of units for each Named Executive Officer and the value of those units based on a per share value of $8.75 as of December 31, 2008. Actual earned Performance Units will fully vest on the payout date in February 2011. Mr. Anderson's units reflect the target number of units that vested upon his retirement date on December 31, 2008 and that were paid in shares, issued on January 2, 2009.

(4)
Restricted Shares granted on April 16, 2007 to Mr. Schramm. These Restricted Shares vested on April 16, 2009, the two-year anniversary of his hire date. The value of the Restricted Shares reflected above is based on the closing share price of $8.75 as of December 31, 2008.

II-31



OPTION EXERCISES AND STOCK VESTED TABLE

 
  Stock Awards  
Name of Executive Officer(a)
  Number of Shares
Acquired on Vesting
(#)(d)
  Value Realized
on Vesting
($)(e)
 

David J. Anderson(1)

    20,241   $ 430,324  

Karl J. Schmidt(1)

    10,577   $ 224,867  

Hans J. Cornett(1)

    9,368   $ 199,164  

Thomas K. Kittel(1)

    6,401   $ 136,085  

Wolfgang Schramm(2)

    5,000   $ 116,100  

Footnotes To Option Exercises and Stock Vested Table

(1)
Amounts and values represent earned Performance Units under the 2005 Performance Unit Awards granted on February 22, 2005, with a Performance Period from January 1, 2005 through December 31, 2007. Based upon achieved RONA performance, the Named Executive Officers listed above earned a payout under these awards equal to 57.5% of target. These earned Performance Units fully vested on the payout date of February 29, 2008. The value reflected is based on the per share value of $21.26 on the payout date.

(2)
Amounts and values reflected represent vesting of restricted shares granted to Mr. Schramm on April 16, 2007. These restricted shares vested on April 16, 2008, the one-year anniversary of his hire date. The value reflected is based on the per share value of $23.22 on the vesting date.

PENSION BENEFITS TABLE

Name(a)
  Plan name(b)   Number of
years of
credited service
(#)(c)
  Present
Value of
Accumulated
Benefit
($)(d)
 

David J. Anderson

  Sauer-Danfoss Employee's Retirement Plan     24.4     780,177  

  Sauer-Danfoss Supplemental Retirement Plan     24.4     1,666,259  

Karl J. Schmidt

  Sauer-Danfoss Employee's Retirement Plan     7.0     30,990  

Hans J. Cornett

  Sauer-Danfoss Employee's Retirement Plan     7.2     33,582  

Thomas K. Kittel

  German Company Pension Scheme     20.9     297,139  

Wolfgang Schramm

  Sauer-Danfoss Employee's Retirement Plan     1.7     5,790  


PENSION BENEFITS NARRATIVE

Sauer-Danfoss Employees' Retirement Plan

        The Pension Benefits table above details the present value of the accumulated retirement benefits accrued by Messrs. Anderson, Schmidt, Cornett and Schramm under the Sauer-Danfoss Employees' Retirement Plan (the "U.S. Retirement Plan"). The amounts shown represent the retirement annuities that each of them would be eligible to receive at normal retirement age (65), based on years of service through December 31, 2008 and discounted to a December 31, 2008 present value using a discount rate of 6.25%.

        The U.S. Retirement Plan is a defined benefit pension plan intended to be qualified under Section 401(a) of the Internal Revenue Code. Under the U.S. Retirement Plan, participants accrue retirement benefits over time using either a final average pay formula or a cash balance formula. The final average pay formula is available only to participants who were hired prior to October 2, 2000 and who did not make a one-time election to switch to the cash balance formula. All other participants accrue benefits under the cash balance formula.

        Under the final average pay formula, a participant's retirement benefit at normal retirement date, age 65, will be based on (i) the average of the participant's highest consecutive five-year annual earnings,

II-32



(ii) the number of years of participation in the plan and (iii) a reduction/offset for Social Security benefits. Under the terms of the plan, the average annual earnings will be multiplied by 2% for each year of participation, up to a maximum of 30 years or 60%, to determine the annual pension amount. The annual pension amount is converted to a monthly annuity. Depending upon hire date, participants may choose from a variety of payment options, including ordinary life annuities, joint and survivor annuities and ordinary life annuities with guaranteed term certain provisions. The portion of a final average pay benefit accrued prior to December 31, 1990 can, at the election of the participant, be paid out in a lump sum.

        Under the cash balance formula, participants are provided an annual credit, equal to 2% of eligible pay, to their cash balance accounts. The cumulative account balances earn annual interest credits, tied to the one-year treasury bill rate. At the normal retirement date, age 65, the accumulated cash balance is converted into a monthly annuity for payment and is paid out as either a single-life annuity or as a joint and survivor annuity.

        For both the final average pay formula and the cash balance formula, eligible pay is generally limited to a participant's base salary.

        Mr. Anderson participates in the U.S. Retirement Plan under the final average pay formula. Messrs. Schmidt, Cornett and Schramm participate in the U.S. Retirement Plan under the cash balance formula. On September 1, 2008, Mr. Cornett transferred to the Company's location in Germany and as such, is no longer accruing additional benefits under the U.S. Retirement Plan. As a German employee, Mr. Kittel does not participate in the U.S. Retirement Plan.

        Under the U.S. Retirement Plan, reduced early retirement benefits may be taken beginning at age 55. Messrs. Anderson (age 61), Schmidt (age 55) and Cornett (age 58) are currently eligible for early retirement under the above-named plan. Upon early retirement, the normal age 65 retirement benefit is reduced by 0.5% for each month by which the participant is less than age 65 when early retirement benefit payments commence.

        Mr. Schramm has not yet served the requisite five years to be vested in his benefits under the U.S. Retirement Plan.

Sauer-Danfoss Supplemental Retirement Plan

        The Internal Revenue Code generally limits to $185,000, indexed for inflation, the amount of any annual benefit that may be paid from the U.S. Retirement Plan. Moreover, the U.S. Retirement Plan may consider no more than $230,000, as indexed for inflation, of a participant's annual compensation in determining that participant's retirement benefit.

        In recognition of these two limitations, the Company has adopted a Supplemental Retirement Benefit Plan (the "U.S. Supplemental Plan"). The U.S. Supplemental Plan is designed to provide supplemental retirement benefits to the extent that a participant's benefits under the U.S. Retirement Plan are limited by either the $185,000 annual benefit limitation or the $230,000 annual compensation limitation. Under the U.S. Supplemental Plan, however, the actual payment of supplemental benefits is entirely at the discretion of the Company.

        The Pension Benefits table above details the present value of the accumulated retirement benefit accrued by Mr. Anderson under the U.S. Supplemental Plan. The amount shown represents the supplemental retirement annuity that Mr. Anderson would be eligible to receive at normal retirement age (65), based on years of service through December 31, 2008 and discounted to a December 31, 2008 present value using a discount rate of 6.25%. No other Named Executive Officer is entitled to benefits under the U.S. Supplemental Plan.

        Under the terms of the U.S. Supplemental Plan, Mr. Anderson's supplemental retirement benefit is payable in a lump sum on the first payroll date following the twelve-month anniversary of his termination

II-33



of employment date. As Mr. Anderson retired on December 31, 2008, the supplemental retirement benefit will be payable in January 2010. The lump sum supplemental retirement benefit payable to Mr. Anderson is projected to be approximately $1.8 million.

        Messrs. Schmidt, Cornett, and Schramm are covered by a separate, nonqualified deferred compensation plan which provides additional benefits for cash balance account participants in the U.S. Retirement Plan whose retirement benefits are limited by the Internal Revenue Code limitations on qualified plans. This separate plan is discussed in the Nonqualified Deferred Compensation narrative which follows below.

German Company Pension Scheme

        The Pension Benefits Table above details the present value of the accumulated retirement benefit accrued by Mr. Kittel under the German Company Defined Benefit Pension Scheme. The amount shown represents the retirement annuity that Mr. Kittel would be eligible to receive at normal retirement age (65), based on years of service through December 31, 2008, discounted to a December 31, 2008 present value using a discount rate of 5.75%.

        The German Company Defined Benefit Pension Scheme is a pension plan covering a majority of the Company's German employees. The plan is similar in nature to a defined benefit plan in the United States, with the exception that the plan is unfunded. Under the plan, a monthly pension is paid to employees who retire after attaining the age of 65, calculated pursuant to a formula based on (i) a percentage of each employee's base monthly salary as of the end of October of each year and (ii) the participant's years of service. Mr. Kittel had completed 20.9 years of service in the plan as of December 31, 2008.

        The German Company Defined Benefit Pension Scheme was replaced by a defined contribution retirement plan for German employees, effective October 1, 2007. Mr. Kittel's defined benefit pension benefit was effectively frozen as of October 1, 2007 with no further benefit accruals for additional service. Messrs. Kittel and Cornett received contributions into the German defined contribution plan during 2008. These contributions are reflected in the All Other Compensation column of the Summary Compensation Table.

NONQUALIFIED DEFERRED COMPENSATION TABLE

Name(a)
  Executive
Contributions
In Last FY
($)(b)
  Registrant
Contributions
In Last FY
($)(c)
  Aggregate
Earnings In
Last FY
($)(d)
  Aggregate
Withdrawals Or
Distributions
($)(e)
  Aggregate
Balance At
Last FYE
($)(f)
 

David J. Anderson(2)(3)(4)

    0     0     (657,191 )   266,110     1,162,003  

Karl J. Schmidt(1)(2)(3)(4)

    0     5,654     (420,147 )   0     293,677  

Hans J. Cornett

    0     0     (2,788 )   0     14,179  

Thomas K. Kittel

    0     0     0     0     0  

Wolfgang Schramm(1)

    0     4,754     0     0     4,754  

Footnotes To Nonqualified Deferred Compensation Table

(1)
The amounts reflected as Registrant Contributions in the Last Fiscal Year for Messrs. Schmidt and Schramm relate to Company contributions to the Supplemental Executive Savings and Retirement Plan and are included under All Other Compensation in the Summary Compensation Table.

(2)
$11,272 and $286 of the amounts shown as Aggregate Earnings in the Last Fiscal Year for Messrs. Anderson and Schmidt, respectively, represent above-market earnings on nonqualified, deferred compensation and are included under Change in Pension Value and Nonqualified Deferred Compensation Earnings in the Summary Compensation Table. Above-market earnings are computed using 120% of the applicable federal long-term rate as the basis for market earnings.

(3)
($740,641), and ($435,259) of the amounts shown as Aggregate Earnings in the Last Fiscal Year for Messrs. Anderson and Schmidt, respectively, result from a decrease in the value of deferred Performance Units, attributable to the underlying decline

II-34


    in the Company's common stock value. The deferred Performance Units are payable in Company stock and, therefore, their value fluctuates with changes in the Company's stock value.

(4)
$377,790, and $233,651 of the amounts shown as Aggregate Balance at Last Fiscal Year-End for Messrs Anderson, and Schmidt, respectively, represents the value of their deferred Performance Units, using the Company's closing share price on December 31, 2008 of $8.75.


NONQUALIFIED DEFERRED COMPENSATION NARRATIVE

        The nonqualified deferred compensation amounts shown above reflect participants' balances in the following three nonqualified deferred compensation plans or arrangements:

    Elective Deferred Compensation Plans for Cash Compensation

    Elective Deferred Compensation Plans for Long-Term Incentive Compensation

    Supplemental Executive Savings & Retirement Plan

        The elective deferred compensation plans provide a means for eligible executives to save a portion of their compensation, on a tax-deferred basis, for retirement and other purposes.

        The Supplemental Executive Savings and Retirement Plan operates to provide additional Company contributions to Messrs. Schmidt and Schramm, whose Company contributions into their qualified retirement plans are limited by IRS rules. These additional contributions allow the affected executives to receive, on a percentage of compensation basis, the same level of Company contributions towards retirement that all other U.S. employees enjoy. Mr. Cornett maintains a balance in the Supplemental Executive Savings and Retirement plan relating to Company contributions and earnings thereon stemming from the time of his U.S. employment.

        The key provisions of the three nonqualified, deferred compensation plans are reflected below.

Elective Deferred Compensation Plans for Cash Compensation

    Plan available to selected U.S. employees

    May elect deferral of all or a portion of Base Salary and Annual Incentive Award

    Unfunded, unsecured liability of the Company

    Deferred compensation earned after 2004 subject to a variable earnings credit tied to ten-year U.S. treasury yields plus a credit risk spread based on the Company's credit profile (2008 annualized return—6.3%)

    Deferred compensation earned prior to 2005 subject to a variable earnings credit tied to ten-year U.S. treasury yields plus 3% (2008 annualized return—6.8%)

    Payouts to be made in cash

    Deferral elections and payout options comply with Internal Revenue Code Section 409A rules

Elective Deferred Compensation Plan for Long-Term Incentive Compensation

    Plan available to selected U.S. employees

    May elect deferral of all or a portion of payouts under Long-Term Incentive Plan

    Unfunded, unsecured liability of the Company

    Deferrals retain the form of Performance Units

    Deferred Performance Units are paid out in cash or shares as originally determined by the Compensation Committee

II-35


    Dividend equivalents earned on the deferred units are credited at the same rate as dividends on the Company's common shares and are deferred until Performance Unit payout

    Deferred dividend equivalents credited with a variable earnings credit tied to ten-year U.S. treasury yields plus a credit risk spread based on the Company's credit profile (2008 annualized return—6.3%)

    Deferred dividend equivalents and earnings thereon paid out in cash at end of deferral period

Supplemental Executive Savings and Retirement Plan

    Non-elective plan available to any cash balance participants in the Company's qualified retirement plans whose retirement benefits are limited by IRS rules

    Unfunded, unsecured liability of the Company

    A portion of the deferred compensation balance earns interest credits based on one-year treasury bill rates similar to cash balance account earnings (2008 annualized return—3.17%)

    A portion of the deferred compensation balance is self-directed by the participants and can generate earnings or loss based on actual performance from investment options in the Company's 401(k) plan. A participant's actual, annualized return or loss will depend on the hypothetical investment strategy that the participant employs. Messrs. Schmidt and Cornett realized losses of 37.4% and 25.7%, respectively, with respect to their hypothetical investment strategy in 2008.

    Amounts payable in cash, generally on the six-month anniversary of employment termination

    Alternative payout options for reasons such as death and disability comply with Internal Revenue Code Section 409A rules

II-36



POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL

        Each Named Executive Officer has entered into an Employment Agreement with Sauer-Danfoss which provides for the payment of certain amounts upon a termination of employment for various reasons. These amounts are in addition to the amounts shown above in the Pension Benefits Table and the Nonqualified Deferred Compensation Table.

        Upon termination of employment for any reason, a Named Executive Officer will receive base salary, vacation pay, and Annual Incentive Awards that have been earned, but not yet paid.

        The Named Executive Officer will receive additional payments if the termination from employment occurs in any of the following circumstances:

    Following a Change in Control of the Company

    Termination initiated by the Company without cause

    Termination initiated by the Named Executive Officer with good reason

    Death or disability

        The following table sets forth the estimated value of these potential post-employment payments assuming a triggering event had occurred on December 31, 2008, after the vesting of the 2008 Annual Incentive Award, and based on the closing share price on December 31, 2008 of $8.75 and using base salaries in effect on that date. The tabular disclosure is followed by a more detailed narrative concerning the various types of triggering events. The table reflects the actual value of Mr. Anderson's post-employment compensation payable in 2009.

POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL TABLE

TABULAR DISCLOSURE—OTHER POTENTIAL POST-EMPLOYMENT PAYMENTS

Named Executive Officer
  Triggering Event For Termination   Base
Salary
Multiple
(A)
  Annual
Incentive
Multiple
(B)
  Medical
Benefit
Continuation
(C)
  Total
Paid To
NEO
(A)+(B)+(C)
  Excise
Tax
Protection
  Total
Cash
Payments
  Accelerated
Vesting Of
Performance
Units(1)(2)
 

David J. Anderson

  Without Cause/For Good Reason     975,000     877,500     0     1,852,500     N/A     1,852,500     502,653  

Karl J. Schmidt

 

Death or Disability

   
327,000
   
0
   
12,192
   
339,192
   
N/A
   
339,192
   
N/A
 

  Without Cause/For Good Reason     490,500     294,300     12,192     796,992     N/A     796,992     N/A  

  Change In Control     490,500     294,300     32,700     817,500     0     817,500     429,126  

Hans J. Cornett

 

Death or Disability

   
409,776
   
0
   
0
   
409,776
   
N/A
   
409,776
   
N/A
 

  Without Cause/For Good Reason     614,664     368,798     0     983,462     N/A     983,462     N/A  

  Change In Control     614,664     368,798     40,978     1,024,440     N/A     1,024,440     410,244  

Thomas K. Kittel

 

Death or Disability

   
409,776
   
0
   
0
   
409,776
   
N/A
   
409,776
   
N/A
 

  Without Cause/For Good Reason     614,664     368,798     0     983,462     N/A     983,462     N/A  

  Change In Control     614,664     368,798     40,978     1,024,440     N/A     1,024,440     393,435  

Wolfgang Schramm

 

Death or Disability

   
0
   
0
   
12,192
   
12,192
   
N/A
   
12,192
   
N/A
 

  Without Cause/For Good Reason     468,000     280,800     12,192     760,992     N/A     760,992     N/A  

  Change In Control     468,000     280,800     31,200     780,000     0     780,000     292,714  

        The narrative descriptions which follow are generally based on the employment agreement provisions for Messrs. Anderson, Schmidt, and Schramm. Mr. Cornett's and Mr. Kittel's employment agreements were replaced by German employment law compliant agreements that contain longer notice periods (7 months vs. 30 days) than the other agreements. Due to the longer notice period, the cash payments stemming from certain terminations, as described below, are reduced from 11/2 times to 1 times base salary and target annual incentive for Messrs. Cornett and Kittel.

II-37


Payments Due To Death Or Disability

        In the event of a termination of employment due to Death or Disability, the Named Executive Officer or his estate or beneficiary, as the case may be, shall receive the following payments and/or continuing benefits:

    A cash payment equal to 100% of base salary

    A cash payment equal to the earned Annual Incentive for the year of termination, adjusted to reflect the number of months the Executive worked in the year prior to termination of employment

    The continuation of Company-provided medical benefits for a twelve-month period at no additional cost

        The Employment Agreements define Disability to mean the inability of the Named Executive Officer to perform his principal duties because of physical or mental incapacity for 180 consecutive days in any twelve-month period.

        Mr. Schramm's Employment Agreement does not provide for the payment of the lump sum cash payment equal to 100% of base salary, in the event of termination of employment due to Death or Disability.

Payments Due To Termination By Company Without Cause & Termination By Employee With Good Reason

        In the event of a termination of employment initiated by the Company Without Cause or initiated by the Employee With Good Reason, the Named Executive Officer shall receive the following payments and/or continuing benefits:

    A cash payment equal to 150% of base salary

    A cash payment equal to 150% of the Annual Incentive Plan target award

    A cash payment equal to the earned Annual Incentive for the year of termination, adjusted to reflect the number of months the Executive worked in the year prior to termination of employment

    The continuation of Company-provided medical benefits for a twelve-month period at no additional cost

    Executive level career outplacement services

        Under the Employment Agreements the circumstances under which the Company can terminate employment of a Named Executive Officer for Cause and thereby avoid the payment described in this section are limited to the following:

    the willful failure of the Named Executive Officer to perform his material duties with the Company, which failure is not cured within 15 days of written notice from the Company

    the engaging by the Named Executive Officer in willful conduct that is demonstrably injurious to the Company

    the conviction of the Named Executive Officer of a felony offense

    a failure by the Named Executive Officer to comply with any material provision of the Employment Agreement, which failure is not cured within 15 days of written notice from the Company

II-38


        Under the Employment Agreements, the following circumstances would allow the Named Executive Officer to terminate his employment under the With Good Reason clause and thereby qualify for the payments described in this section:

    a material adverse alteration in the nature or status of the Named Executive Officer's position, duties, responsibilities or authority

    a material reduction in the Named Executive Officer's Base Salary or level of employee benefits (other than across-the-board reductions applied similarly to all of the Company's senior executives)

    failure to pay or provide any of the compensation set forth in this Agreement, which failure is not cured within 15 days after receipt of written notice from the Named Executive Officer

    the relocation of the Executive's principal place of employment by more than 50 miles

    a failure by the Company to comply with any material provision of the Employment Agreement, which failure is not cured within 15 days of written notice from the Named Executive Officer

        The right to invoke a Termination With Good Reason action must be initiated within 60 days of the underlying event to be effective. Also, the right to initiate a Termination With Good Reason action can be waived by the Executive, in writing.

Payments Following A Change In Control

        In the event of a termination of employment within the first two years following a Change In Control of the Company that is either initiated by the Company Without Cause or initiated by the Employee With Good Reason, the Named Executive Officer shall receive the following payments and/or continuing benefits:

    A cash payment equal to 150% of base salary

    A cash payment equal to 150% of the Annual Incentive Plan target award

    A cash payment equal to the earned Annual Incentive for the year of termination, adjusted to reflect the number of months the Executive worked in the year prior to termination of employment

    A cash payment equal to 10% of base salary, in lieu of continuing medical benefits

    An excise tax gross-up payment in the event that the Change in Control payments result in an "excess parachute payment" under Internal Revenue Code Section 280G

        A Change In Control is generally defined as an acquisition by an unrelated third party of a 30% or greater interest in the ownership of the Company. The 2008 transaction whereby Danfoss A/S acquired a majority stake in Sauer-Danfoss Inc. did not constitute a Change in Control for purposes of the Employment Agreements of the Named Executive Officers.

        The excise tax gross-up payment is intended to make the Named Executive Officer whole in the event that any excise tax is owed under Internal Revenue Code Section 280G. The excise tax gross-up payment will cover not only the excise tax itself, but will be grossed-up to cover additional income and excise taxes owed as a result of the gross-up payment.

        Mr. Schramm's Employment Agreement does not provide for the payment of the excise tax gross-up payment. Mr. Schramm's Employment Agreement does allow for a reduction of payouts to the minimum amount needed to avoid any excise tax under Internal Revenue Code Section 280G, if this is deemed to be more advantageous to Mr. Schramm.

        In the event of a Change In Control, Performance Units under the Company's Long-Term Incentive Plan are subject to accelerated vesting. The Performance Units vest at their target level and are payable immediately upon vesting.

II-39


Key Employment Agreement Provisions

        In return for the agreement by the Company to make the other potential post-employment payments described above, the Named Executive Officers agree to certain conduct during the term of their employment and immediately thereafter. Specifically, the Named Executive Officers, by signing the Employment Agreements, agree to the following:

    A Covenant Not To Compete with the Company for a period of up to 18 months following any termination of employment

    Non-Disclosure of Company Confidential Information

    Assignment of any and all Development rights on intellectual property conceived of or devised while employed

    Non-Solicitation of Company personnel for a period of up to 18 months following any termination of employment


DIRECTOR COMPENSATION TABLE

Name(a)
  Fees earned or
paid in cash
($)(b)
  Stock
Awards(1)
($)(c)
  Change in
Pension Value and
Nonqualified
Deferred
Compensation
Earnings(2)(f)
  All Other
Compensation(3)
($)(g)
  Total
($)(h)
 

Jørgen M. Clausen

    96,750     37,033           3,240     137,023  

Sven Murmann

    64,250     37,033           3,240     104,523  

Steven H. Wood

    51,250     37,033     925     3,240     92,448  

Johannes F. Kirchhoff

    51,250     37,033           3,240     91,523  

F. Joseph Loughrey

    51,250     37,033           3,240     91,523  

Ole Steen Andersen

    16,000     53,945           1,620     71,565  

Nicola Keim

    16,000     53,945           1,620     71,565  

Hans Kirk

    16,000     53,945           1,620     71,565  

Klaus H. Murmann

    16,000     53,945           1,620     71,565  

Niels Christiansen

    21,250     7,445           540     29,235  

Frederik Lotz

    21,250     7,445           540     29,235  

Sven Ruder

    21,250     7,445           540     29,235  

Bill Hoover

    20,500     7,445           540     28,485  

Kim Fausing

    19,750     7,445           540     27,735  

Footnotes To Director Compensation Table

(1)
These amounts represent the financial statement expense under FAS 123R on restricted shares held by each non-employee director. Further information concerning the Company's accounting for restricted stock under FAS 123R can be found in footnote number 13 to its consolidated financial statements filed as part of its Form 10-K for the year ended December 31, 2008. At December 31, 2008 Messrs. Clausen, Sven Murmann, Wood, Kirchhoff and Loughrey each held 4,500 shares of restricted stock. Messrs. Christiansen, Lotz, Ruder, Hoover, and Fausing each held 1,500 shares of restricted stock.

On April 27, 2005, 1,500 shares vested and became unrestricted for Messrs. Claussen, Sven Murmann, Wood, Kirchhoff, Loughrey, Andersen, Kirk, Klaus Murmann and Ms. Keim. On July 10, 2008, 3,000 shares vested and became unrestricted for Messrs. Andersen, Kirk, Klaus Murmann and Ms. Keim. The July 10, 2008 vesting represented an early vesting upon their termination from Board service and was approved by the full Board in recognition of their past service as board members.

(2)
Mr. Wood participates in the Sauer-Danfoss Inc. 409A Deferred Compensation Plan for Selected Employees and U.S. Non-employee Directors. In 2008 he elected to defer 75% of the fees reflected under Fees Earned or Paid in Cash in this table. The amount reported under Change in Pension Value and Nonqualified Deferred Compensation Earnings reflects above-market earnings on his deferred director fees, using 120% of the applicable federal long-term rate as the basis for market earnings.

(3)
The non-employee directors have dividend rights with respect to the restricted shares prior to vesting. Amounts reflected in this column represent the value of dividends earned on restricted shares during 2008.

II-40



DIRECTOR COMPENSATION NARRATIVE

        Non-employee directors earn cash-based director's fees according to the following schedule, effective July 1, 2008:

    As Chairman, Mr. Clausen receives a retainer of $100,000 per year

    As Vice Chairman, Mr. Sven Murmann receives a retainer of $75,000 per year

    All other non-employee directors receive retainers of $35,000 per year

    All non-employee directors receive $1,500 for each Board meeting attended

    All non-employee directors receive $750 for participation in a telephonic meeting

    Non-employee directors receive an annual retainer of $7,000 for service on the Compensation Committee and $7,000 for service on the Audit Committee. Messrs. Kirchhoff, Loughrey and Wood serve on both the Audit Committee and the Compensation Committee.

        Effective for the first quarter of 2009, the annual retainers for Messrs. Clausen and Sven Murmann have been reduced to $75,000 and $55,000, respectively.

        Non-employee directors receive an annual grant of restricted shares of Sauer-Danfoss Inc. common stock under the Company's Non-Employee Director Stock Option and Restricted Stock Plan. The terms of each restricted share grant can vary in accordance with the plan document. For the past several years the annual grants have consisted of 1,500 shares with a three-year vesting period. The restricted shares are forfeitable upon termination of service from the Board for any reason prior to the vesting date, unless otherwise determined by the Board, in its sole discretion. The restricted shares provide for voting and dividend rights during the period of restriction.

        U.S. non-employee directors can elect to defer a portion of their cash-based director's fees by participating in the Sauer-Danfoss Inc. 409A Deferred Compensation Plan for Selected Employees and U.S. Non-Employee Directors. The terms of such deferral are similar to those made available to Sauer-Danfoss employees and have been described previously in the Nonqualified Deferred Compensation Narrative.

        Mr. Anderson served as an employee member of the Board through the 2008 annual shareholders meeting. As an employee board member, Mr. Anderson was not entitled to any compensation for such service. Subsequent to his retirement on December 31, 2008, Mr. Anderson will serve as Co-Vice Chairman of the Board in a non-voting capacity through the 2009 annual shareholders meeting. Mr. Anderson will receive compensation equivalent to a regular, non-employee director for this service,

        Mr. Ruder will continue on the board after his January 1, 2009 appointment as President and Chief Executive Officer. Effective January 1, 2009 Mr. Ruder's directors fees were discontinued as he has become an employee board member.

II-41



ITEM 1—ELECTION OF DIRECTORS

        The Board of Directors of the Company (the "Board") has nominated ten directors for election. All directors are elected annually.

        If elected, each of the nominees will serve until the 2010 Annual Meeting and until a successor has been elected and qualified, or until such director's earlier death, resignation, or removal.

        Each share is entitled to one vote for each of ten directors. The persons named in the accompanying proxy will vote it for the election of the nominees named below as directors unless otherwise directed by the stockholder. Each nominee has consented to be named and to serve if elected. In the unanticipated event that a nominee becomes unavailable for election for any reason, the proxies will be voted for the other nominees and for any substitute.

Nominees to Serve for Directors

        Niels B. Christiansen, age 43, has been a director of the Company since July 10, 2008. Mr. Christiansen was appointed President and Chief Executive Officer of Danfoss A/S on October 1, 2008. Prior to that, he had been Vice Chief Executive Officer of Danfoss A/S since November 15, 2006. From November 15, 2006 through December 31, 2007, he also served as Chief Operating Officer of Danfoss A/S. From November 1, 2004 through November 14, 2006, he served as Executive Vice President and Chief Operating Officer of Danfoss A/S. From January 1, 2003 through September 30, 2004, Mr. Christiansen was an Executive Vice President at GN Store Nord A/S, a Danish developer of telecommunications networking and hand-held communications solutions. From January 1, 2000 through September 30, 2004, he was President and Chief Executive Officer of GN Netcom A/S, a Danish subsidiary of GN Store Nord A/S.

        Mr. Christiansen is a member of the Executive Committee of Danfoss A/S and serves on the Boards of Directors of Axcel A/S, a Danish private equity fund, TrygVesta A/S, a publicly traded Danish insurance company, B&O a/s, a publicly traded Danish manufacturer of audio and video products, and William Demant Holding A/S, a publicly traded Danish manufacturer of audio products.

        Jørgen M. Clausen, age 60, has been a director of the Company since May 3, 2000, Chairman of the Company since May 5, 2004, and prior to that served as Vice Chairman of the Company from 2000 to 2004. On October 1, 2008, Mr. Clausen announced his retirement as President and Chief Executive Officer of Danfoss A/S. He serves as the Chairman of Danfoss A/S.

        Kim Fausing, age 44, has been a director of the Company since July 10, 2008. Mr. Fausing has been Executive Vice President and Chief Operating Officer of Danfoss A/S since January 2008. In 2007, Mr. Fausing became a divisional president of Danfoss A/S, having previously worked at Hilti Corporation, a privately owned manufacturer of construction and engineering products, from 1990 through 2007. He served as Hilti's President and Managing Director from 1990 through 2003, and as a Division President and Member of its Executive Committee from 2003 through 2007.

        William E. Hoover, Jr., age 59, has been a director of the Company since July 10, 2008. Mr. Hoover worked for McKinsey & Co., a management consulting firm, for approximately 30 years until July 2007. Mr. Hoover serves on the Boards of Directors of Danfoss A/S, GN Great Nordic, a Danish manufacturer of hearing instruments that is listed on the Copenhagen Stock Exchange, and NorthStar Battery, a privately owned firm that makes batteries for mobile base stations. He is the Vice Chairman of the GN Great Nordic board.

        Johannes F. Kirchhoff, age 51, has been a director of the Company since April 17, 1997. Mr. Kirchhoff has been owner and Managing Director of FAUN Umwelttechnik GmbH & Co. KG, a German manufacturer of vehicles for waste disposal, for more than the past five years. He is Chairman of the Compensation Committee of the Board and a member of the Audit Committee of the Board.

II-42


        F. Joseph Loughrey, age 59, has been a director of the Company since June 23, 2000. After 35 years of service with Cummins Inc., Mr. Loughrey retired on April 1, 2009. He has been Vice Chairman of Cummins Inc. since August 1, 2008 and served as its President and Chief Operating Officer from May 2005 until August 2008. From October 1999 until May 2005, he was Executive Vice President of Cummins Inc. and President—Engine Business. From 1996 to 1999, Mr. Loughrey served as Executive Vice President of Cummins Engine Company and Group President—Industrial and Chief Technical Officer. He serves on the Boards of Directors of Hillenbrand, Inc., an Indiana corporation with shares listed on the NYSE; the Lumina Foundation, an Indianapolis-based private foundation that works to expand access to post secondary education in the United States; AB SKF, a Swedish corporation with shares quoted on the NASDAQ OMX Stockholm; and Cummins Inc., an Indiana corporation with shares listed on the NYSE. Mr. Loughrey is not standing for re-election at Cummins Inc.'s annual meeting on May 12, 2009. Mr. Loughrey is a member of the Audit Committee and the Compensation Committee of the Board.

        Frederik Lotz, age 40, has been a director of the Company since July 10, 2008. Mr. Lotz has been Executive Vice President and Chief Financial Officer of Danfoss A/S since May 1, 2007. He began to serve as an Executive Vice President of Danfoss A/S on February 1, 2007. He served as Chief Financial Officer of Ferrosan A/S, a Danish corporation in the consumer health care industry, from December 1, 2002 through December 31, 2006.

        Sven Murmann, age 41, has been a director of the Company since April 21, 1994, and Vice Chairman of the Company since May 5, 2004. Mr. Murmann is Managing Director of Sauer Holding GmbH, an investment company controlled by the Murmann family, a position he has held for more than the past five years, and is a member of the Board of Directors of Cartagena Group Inc., a real estate company held by Klaus H. Murmann. Mr. Murmann is also a member of the Board of Directors of ICF Solutions Inc., which is active in the property market and held by a subsidiary of Sauer Holding GmbH. He previously served from 2000 to 2002 as Manager of HAKO Holding GmbH & Co., a global manufacturer of indoor and outdoor cleaning equipment based in Germany. He is a member of the Board of Danfoss A/S. Mr. Murmann is the son of Klaus H. Murmann, Chairman Emeritus of the Company.

        Sven Ruder, age 52, has been a director of the Company since July 10, 2008. Mr. Ruder became the President and Chief Executive Officer of the Company on January 1, 2009. He served as the President of the Motion Controls division of Danfoss A/S from January 2001 through December 2008. Mr. Ruder serves on the Boards of Directors of Danfoss Turbocor Compressors BV, a privately held joint venture between Danfoss A/S and Turbocorp BV, and of Danfoss Turbocor Compressors, Inc., a subsidiary of Danfoss Turbocor Compressors BV that is engaged in the manufacture of air conditioning and refrigeration compressors.

        Steven H. Wood, age 51, has been a director of the Company since January 1, 2003. Mr. Wood is currently the Chief Financial Officer of Becker-Underwood, Inc., a supplier of non-pesticide specialty chemical and biological products within the agricultural, landscape, turf, and horticulture industries. He was formerly Vice President and Corporate Controller for Metaldyne Corporation, a global designer and supplier of metal-based components, assemblies and modules for the automotive industry, from May 2004 until May 2006. From 2000 until 2003, he was the Executive Vice President and Chief Financial Officer of Maytag Corporation, and from 1996 to 2000 he was Vice President-Financial Reporting and Audit of Maytag. Mr. Wood held various other financial leadership positions within Maytag from 1989 to 1996. Prior to joining Maytag, he was an auditor with Ernst & Young, a public accounting firm, and successfully completed the examination for Certified Public Accountants. He is Chairman of the Audit Committee and a member of the Compensation Committee of the Board.

        The Board recommends that stockholders vote FOR the election of the nominees named above as directors.

II-43


        The following persons are not directors or nominees for director, but they will continue to attend Board meetings as valued advisors.

        David J. Anderson, age 61, served as a director of the Company from July 1, 2002 until July 10, 2008 and as President and Chief Executive Officer of the Company from July 1, 2002 until December 31, 2008. Mr. Anderson presently serves as the Co-Vice Chairman of the Board in a non-voting, advisory capacity. He served as Executive Vice President—Strategic Business Development of the Company from May 3, 2000, until July 1, 2002. He is the Chairman of the National Fluid Power Association and a member of the Executive Committee of the Association of Equipment Manufacturers' (AEM) Construction Equipment Group.

        Klaus H. Murmann, age 77, served as a director of the Company from April 18, 1990 until July 10, 2008. Mr. Murmann is currently Chairman Emeritus of the Company, a non-voting, advisory position. From 1987 to May 3, 2000, he served as Chairman and Chief Executive Officer of the Company and its predecessor. He retired as an active employee of the Company as of December 31, 2002. Mr. Murmann founded Sauer Getriebe, a predecessor to the Company, in 1967, and has been involved in the hydrostatics business for more than 40 years. He was Chairman of the Board of PSV AG, Cologne, a German national pension fund, for more than five years until he stepped down in July 2006. Klaus Murmann is the father of Sven Murmann, Vice Chairman and a director of the Company.


ITEM 2—RATIFICATION OF APPOINTMENT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

        The Audit Committee of the Board has appointed KPMG LLP as the independent registered public accounting firm to audit the consolidated financial statements of the Company and its subsidiaries for 2009, subject to ratification of the stockholders at the Annual Meeting. A representative of KPMG LLP is expected to be present at the Annual Meeting and will have the opportunity to make a statement and to respond to appropriate questions at the meeting. The affirmative vote of a majority of the shares present and entitled to vote on this item at the Annual Meeting is necessary for the approval of the appointment of KPMG LLP as the Company's independent registered public accounting firm for 2009. In the event stockholders do not ratify the appointment of KPMG LLP, the appointment will be reconsidered by the Audit Committee. Even if the selection is ratified, the Audit Committee in its discretion may direct the appointment of a different independent registered public accounting firm at anytime during the year if they determine that such a change would be in the best interests of the Company and its stockholders.

Fees to Independent Registered Public Accounting Firm for 2008 and 2007

        The following table presents fees for professional services rendered by KPMG LLP for the audit of the Company's Annual Financial Statements for the years ended December 31, 2008 and 2007 and fees billed for other services rendered by KPMG LLP during those periods:

 
  2008   2007  

Audit Fees

  $ 2,290,000   $ 2,376,000  

Audit Related Fees(1)

    42,000     35,000  

Tax Fees(2)

    296,000     224,000  

All Other Fees

    0     0  

(1)
Consists principally of statutory accounting consultations.

(2)
Consists of international and U.S. tax planning and compliance services, and expatriate tax services.

II-44


Policy Regarding Pre-Approval of Audit and Non-Audit Services of Independent Registered Public Accounting Firm

        The Audit Committee's policy is to pre-approve all audit and non-audit services provided by the independent registered public accounting firm. These services may include audit services, audit related services, tax services and other services that are not prohibited from being provided by the independent registered public accounting firm by the Sarbanes-Oxley Act of 2002 or rules issued thereunder ("Permitted Services"). Pre-approval is granted on an annual basis, generally at the first meeting of the Audit Committee held during each year, and any pre-approval shall be detailed as much as possible as to the particular service or category of services and shall generally be subject to a specific budget. The Committee may delegate pre-approval authority to one or more of its members with respect to Permitted Services when expedition of services is necessary, and has delegated such pre-approval authority to its Chairman. The independent registered public accounting firm and management are required to periodically report to the full Audit Committee (generally at each regular quarterly meeting of the Audit Committee, but the Audit Committee may request a report at any time), regarding the extent of services provided by the independent registered public accounting firm in accordance with any pre-approval, and the fees for the services performed to date. All audit fees, audit related fees, tax fees and other fees paid in 2008 and 2007 were pre-approved by the Audit Committee.

        The Board recommends that stockholders vote FOR ratification of the appointment of KPMG LLP as the Company's independent registered public accounting firm for 2009.


ADDITIONAL INFORMATION

Notice Requirements

        To permit the Company and its stockholders to deal with stockholder proposals in an informed and orderly manner, the Bylaws of the Company establish an advance notice procedure. No stockholder proposals, nominations for the election of directors or other business may be brought before an annual meeting unless written notice of such proposal or other business is received by the Secretary of the Company at 2800 E. 13th Street, Ames, Iowa 50010 not less than 120 calendar days in advance of the date that the Company's proxy statement was released to stockholders in connection with the previous year's Annual Meeting. For the Company's annual meeting in the year 2010, the Company must receive this notice on or before December 31, 2009 (i.e., 120 days before April 29, the day this year's proxy statement was released to stockholders). To comply with the Company's Bylaws and applicable rules and regulations of the Securities and Exchange Commission, the notice must contain certain specified information about the matters to be brought before the meeting and about the stockholder submitting the proposal. A copy of the applicable Bylaw provisions may be obtained, without charge, upon written request to the Secretary of the Company at 2800 E. 13th Street, Ames, Iowa 50010.

Discretionary Authority

        If any other matters are properly presented at the Annual Meeting for consideration, including, among other things, consideration of a motion to adjourn the Annual Meeting to another time or place, the persons named as proxies and acting thereunder will have discretion to vote on those matters to the same extent as the person delivering the proxy would be entitled to vote. If any other matter is properly brought before the Annual Meeting, proxies in the enclosed form returned to the Company prior to the Annual Meeting will be voted in accordance with the recommendation of the Board or, in the absence of such a recommendation, in accordance with the judgment of the proxy holder. At the date this Proxy Statement went to print, the Company did not anticipate that any other matters would be properly brought before the Annual Meeting.

II-45


Section 16(a) Beneficial Ownership Reporting Compliance

        Based solely upon a review of Forms 3, 4 and 5 furnished to the Company pursuant to Section 16(a) of the Securities Exchange Act of 1934 with respect to the fiscal year ended December 31, 2008, the Company believes that all of such reports required to be filed during such fiscal year by the Company's officers, directors and 10% beneficial owners were timely filed.

Form 10-K

        The Company will mail without charge, upon written request, a copy of its Annual Report on Form 10-K filed with the Securities and Exchange Commission, including the financial statements, schedules, and list of exhibits. Requests should be sent to Kenneth D. McCuskey, Corporate Secretary, at 2800 E. 13th Street, Ames, Iowa 50010.

    By Order of the Board of Directors

 

 

Kenneth D. McCuskey

 

 

Kenneth D. McCuskey
Corporate Secretary

April 29, 2009

 

 

II-46



SAUER-DANFOSS INC.

2008 ANNUAL REPORT

Business

        Sauer-Danfoss Inc. (the "Company") (NYSE: SHS) is a global leader in the development, manufacture and marketing of advanced systems for the distribution and control of power in mobile equipment. The Company designs, manufactures, and markets hydraulic, electronic, electric, mechanical components, software, and integrated systems that generate, transmit, and control power in mobile equipment for sale to manufacturers of highly engineered, off-road vehicles used for agriculture, construction, road building, turf care, material handling, and specialty vehicles. The Company engineers advanced components and systems to enable its customers to produce highly reliable, efficient and innovative mobile equipment vehicles.

        The composition of the Company's business among its three segments is 48.6% Propel, 26.9% Work Function, and 24.5% Controls. Propel segment products include hydrostatic transmissions, gear boxes, orbital motors, and integrated hydrostatic transaxles. Work Function segment products include steering units, gear pumps and motors, multi-pump assemblies, open circuit pumps, and gear boxes. Controls segment products include a complete line of valves, microcontrollers, solenoid-operated valves, joysticks, speed and positions sensors, grade and slope sensors, and electric drives. All of the segments' products are sold into each of the Company's markets either directly to original equipment manufacturers ("OEMs") or through distributors to OEMs and the aftermarket.


NYSE Price Range, Dividends by Quarter

 
   
  1st   2nd   3rd   4th   Full Year  
2008   High   $ 25.41   $ 37.93   $ 35.10   $ 24.75   $ 37.93  
    Low   $ 17.68   $ 22.23   $ 22.63   $ 5.52   $ 5.52  
    Dividends   $ 0.18   $ 0.18   $ 0.18   $ 0.18   $ 0.72  
                           

2007

 

High

 

$

41.40

 

$

32.11

 

$

31.95

 

$

28.42

 

$

41.40

 
    Low   $ 29.89   $ 25.66   $ 23.12   $ 21.96   $ 21.96  
    Dividends   $ 0.18   $ 0.18   $ 0.18   $ 0.18   $ 0.72  


Certifications

        The Company submitted to the New York Stock Exchange last year, on or about July 29, 2008, the unqualified Section 303A.12(a) Annual CEO Certification.

        The Company also filed as exhibits 31.1 and 31.2 to its Forms 10-K for the years ended December 31, 2008 and December 31, 2007, the certifications of the CEO and CFO required under Section 302 of the Sarbanes-Oxley Act of 2002.

III-1



Performance Graph

        The following graph shows a comparison of the cumulative total returns from December 31, 2003 to December 31, 2008, for the Company, the Russell 2000 Index, and the Hemscott, Inc.—Diversified Machinery Index (the "Hemscott Group Index"). The graph assumes that $100 was invested on December 31, 2003 in the Company's common stock, the Russell 2000 Index, and the Hemscott Group Index, a peer-group index, and that all dividends were reinvested.


COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG SAUER-DANFOSS INC.,
RUSSELL 2000 INDEX AND HEMSCOTT GROUP INDEX

GRAPHIC

ASSUMES $100 INVESTED ON 12/31/03
ASSUMES DIVIDEND REINVESTMENT
FISCAL YEAR ENDED 12/31/08

III-2



Management's Discussion and Analysis of Financial Condition and Results of Operations

Safe Harbor Statement

        This Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as other portions of this annual report on Form 10-K, contain certain statements that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. All statements regarding future performance, growth, sales and earnings projections, conditions or developments are forward-looking statements. Words such as "anticipates," "in the opinion," "believes," "intends," "expects," "may," "will," "should," "could," "plans," "forecasts," "estimates," "predicts," "projects," "potential," "continue," and similar expressions may be intended to identify forward-looking statements.

        Actual future results may differ materially from those described in the forward-looking statements due to a variety of factors. Readers should bear in mind that past experience may not be a good guide to anticipating actual future results. The economies in the U.S., Europe, and Asia-Pacific are suffering from the shockwaves of the worldwide credit crisis, continued weakness in the housing and residential construction markets, growing weakness in the commercial and public-sector construction markets, and uncertainty surrounding job creation, interest rates, and crude oil prices. At this point, it appears that the worldwide economic downturn will continue throughout 2009. Any downturn in the Company's business segments could adversely affect the Company's revenues and results of operations. Other factors affecting forward-looking statements include, but are not limited to, the following: specific economic conditions in the agriculture, construction, road building, turf care, material handling and specialty vehicle markets and the impact of such conditions on the Company's customers in such markets; the cyclical nature of some of the Company's businesses; the ability of the Company to win new programs and maintain existing programs with its original equipment manufacturer (OEM) customers; the highly competitive nature of the markets for the Company's products as well as pricing pressures that may result from such competitive conditions; the continued operation and viability of the Company's significant customers; the Company's execution of internal performance plans; difficulties or delays in manufacturing; cost-reduction and productivity efforts; competing technologies and difficulties entering new markets, both domestic and foreign; changes in the Company's product mix; future levels of indebtedness and capital spending; the ability and willingness of Danfoss A/S, the Company's majority stockholder, to lend money to the Company at sufficient levels and on terms favorable enough to enable the Company to meet its capital needs; the Company's ability to access the capital markets or traditional credit sources to supplement or replace the Company's borrowings from Danfoss A/S if the need should arise; claims, including, without limitation, warranty claims, field retrofit claims, product liability claims, charges or dispute resolutions; ability of suppliers to provide materials as needed and the Company's ability to recover any price increases for materials in product pricing; the Company's ability to attract and retain key technical and other personnel; labor relations; the failure of customers to make timely payment; any inadequacy of the Company's intellectual property protection or the potential for third-party claims of infringement; global economic factors, including currency exchange rates; the sub-prime credit market crisis, credit market disruptions, and significant changes in capital market liquidity and funding costs affecting the Company and its customers; general economic conditions, including interest rates, the rate of inflation, and commercial and consumer confidence; energy prices; the impact of new or changed tax and other legislation and regulations in jurisdictions in which the Company and its affiliates operate; actions by the U.S. Federal Reserve Board and the central banks of other nations; actions by other regulatory agencies, including those taken in response to the global credit crisis; actions by rating agencies; changes in accounting standards; worldwide political stability; the effects of terrorist activities and resulting political or economic instability; natural catastrophes; U.S. military action overseas; and the effect of acquisitions, divestitures, restructurings, product withdrawals, and other unusual events.

        The Company cautions the reader that these lists of cautionary statements and risk factors may not be exhaustive. The Company expressly disclaims any obligation or undertaking to release publicly any updates or changes to these forward-looking statements that may be made to reflect any future events or circumstances.

III-3


About the Company

        Sauer-Danfoss Inc. and subsidiaries (the Company) is a worldwide leader in the design, manufacture, and sale of engineered hydraulic and electronic systems and components that generate, transmit and control power in mobile equipment. The Company's products are used by original equipment manufacturers (OEMs) of mobile equipment, including construction, road building, agricultural, turf care, material handling, and specialty equipment. The Company designs, manufactures, and markets its products in the Americas, Europe, and the Asia-Pacific region, and markets its products throughout the rest of the world either directly or through distributors.

Executive Summary of 2008 Compared to 2007

        The nature of the Company's operations as a global producer and supplier in the fluid power industry means the Company is impacted by changes in local economies, including currency exchange rate fluctuations. In order to gain a better understanding of the Company's base results, a financial statement user needs to understand the impact of those currency exchange rate fluctuations. The following table summarizes the change in the Company's results from operations by separately identifying changes due to currency fluctuations and the underlying change in operations from 2007 to 2008. This analysis is more consistent with how the Company's management internally evaluates results.

 
  2007   Currency
fluctuations
  Underlying
change
  2008  
 
  (in millions)
 

Net Sales

  $ 1,972.5   $ 85.0   $ 33.0   $ 2,090.5  
 

Gross Profit

    427.7     21.9     (14.0 )   435.6  
 

% of Net Sales

    21.7 %               20.8 %

Selling, general and administrative

    233.8     10.4     14.3     258.5  

Research and development

    70.6     3.6     8.7     82.9  

Impairment charges

            58.2     58.2  

Loss on sale of businesses and asset disposals

    9.4     0.5     (0.3 )   9.6  
                   
 

Total operating costs

    313.8     14.5     80.9     409.2  
                   
 

Operating income

    113.9     7.4     (94.9 )   26.4  
 

% of Net Sales

    5.8 %               1.3 %

Net interest expense

    (22.7 )   (0.9 )   (1.0 )   (24.6 )

Other income (expense), net

    (3.6 )   (2.3 )   6.8     0.9  
                   

Income before taxes and minority interest

    87.6     4.2     (89.1 )   2.7  

Minority interest

    (21.6 )   (0.5 )   4.3     (17.8 )
                   
 

Income (loss) before taxes

    66.0     3.7     (84.8 )   (15.1 )
 

% of Net Sales

    3.3 %               (0.7 )%
 

Income tax expense

    (18.8 )   (0.8 )   5.6     (14.0 )
                   

Net income (loss)

  $ 47.2   $ 2.9   $ (79.2 ) $ (29.1 )
                   

        Net sales for the year ended December 31, 2008 increased 2 percent compared to the year ended December 31, 2007, excluding the effects of currency. Sales increased 3 percent excluding the effects of currency and divestitures. Excluding the effects of currency and divestitures, sales increased 3 percent in the Americas and 23 percent in Asia Pacific, while sales remained nearly level in Europe. Sales in the Propel segment were up 4 percent, sales in the Work Function segment increased 2 percent and sales in the Controls segment increased 1 percent.

        Gross profit declined 3 percent during the year ended December 31, 2008, excluding the impact of currency. This decline is primarily driven by $11.2 million in severance costs related to recent actions taken in response to the slowing economy, and a $10.4 million increase in field recall costs, primarily related to

III-4



the Controls segment. During the year ended December 31, 2007, the Propel and Controls segments incurred $10.4 million of restructuring costs primarily to relocate production lines to other production facilities within the Company and remaining costs to close the LaSalle, Illinois plant.

        Selling, general and administrative costs increased 6 percent during 2008 when compared to the same period in 2007, excluding the effects of currency. This increase is primarily attributed to $4.9 million of severance costs, and a $7.8 million increase in sales and marketing costs, excluding the impacts of currency, due primarily to the addition of a new sales office in Russia, as well as increases in headcount earlier in 2008. Research and development costs increased 12 percent excluding the impacts of currency, primarily driven by increasing product development, particularly in the Controls and Propel segments.

        The Company reported impairment charges of $58.2 million, consisting of goodwill impairment charges of $22.9 million and property, plant, and equipment impairment charges of $35.3 million. The goodwill impairment related to the motors and steering reporting units within the Work Function segment and the electric drives reporting unit within the Controls segment. It was incurred as a result of lower profitability in the reporting units than the Company had previously expected, and lower future expectations in certain end markets. The property, plant and equipment impairment related to the Work Function segment and resulted from lower expectations related to the products produced within the asset group.

        During the year ended December 31, 2008 the Company signed an agreement to sell its alternating current (AC) electric motor business for the material handling market. In connection with this transaction, which is expected to close in 2009, the Company incurred charges of $8.4 million in 2008. During the year ended December 31, 2007 the Company incurred a loss of $6.6 million related to the sale of the direct current (DC) electric motor business located in Berching, Germany and a loss of $2.4 million on the sale of the assets and product lines which were manufactured in Swindon, England. These activities were part of the Company's plan to divest of product lines that do not fit the Company's long-term strategic direction.

        During the year ended December 31, 2008, the Propel segment recorded a gain of $1.4 million related to the sale of the LaSalle, Illinois plant and the Controls segment incurred $0.4 million of equipment write-off costs related to the closure of the facility in Hillsboro, Oregon.

Operating Results—2008 Compared to 2007

Sales Growth by Market

        The following table summarizes the Company's sales growth by market. The table and following discussion is on a comparable basis, which excludes the effects of currency fluctuations.

 
  Americas   Asia-Pacific   Europe   Total  

Agriculture/Turf Care

    4 %   3 %   22 %   10 %

Construction/Road Building

    (5 )   12     (11 )   (5 )

Material Handling/Specialty

    (13 )   77     (8 )   (5 )

Distribution

    9     14     0     7  

Agriculture/Turf Care

        Sales into the agriculture/turf care markets increased 10 percent during the year ended December 31, 2008 compared to 2007. Agriculture sales in Europe remained strong throughout 2008, but started to show signs of slowing towards the end of the year. Agriculture sales increased in the Americas due to strong commodity prices, however they started to show signs of weakening late in 2008. Increased sales into the Americas agriculture market were offset by decreased sales into the turf care market, primarily driven by the decline in housing starts and concerns regarding the slowing economic conditions.

III-5


Construction/Road Building

        Sales into the construction/road building markets decreased 5 percent during 2008, with the majority of the decrease occurring in the fourth quarter. The decrease is driven by an 11 percent decrease in the European market and a 5 percent decrease in the Americas market, both due to weakening economic conditions, reduced housing starts, and customers' focus on reducing inventory levels. Asia-Pacific experienced a 12 percent increase due to strength in the Chinese road building market throughout most of 2008, although this market began to show signs of weakening during the fourth quarter of 2008. Export sales out of the Asia-Pacific region also started to weaken during the fourth quarter of 2008.

Material Handling/Specialty

        Specialty vehicles are comprised of a variety of markets including forestry, material handling, marine, waste management and waste recycling. Overall the material handling/specialty markets declined 5 percent, driven by declines in Europe and the Americas due to weak non-residential construction and reductions in capital expenditures by rental companies. Sales through the third quarter of 2008 were level with 2007 but decreased in the fourth quarter as a result of the economic downturn. The decreases in Europe and the Americas were partly offset by strength in the Asia-Pacific region due primarily to a strong market for railway construction machines.

Distribution

        Products related to all of the above markets are sold to distributors, who then serve smaller OEMs.

Order Backlog

        The following table shows the Company's order backlog and orders written activity for 2007 and 2008, separately identifying the impact of currency fluctuations.

 
  2007   Currency
fluctuation
  Underlying
change
  2008  
 
  (in millions)
 

Backlog at December 31

  $ 921.4   $ (16.2 ) $ (161.5 ) $ 743.7  

Orders written

    2,214.8     77.8     (364.9 )   1,927.7  

        Total order backlog at the end of 2008 was $743.7 million, compared to $921.4 million at the end of 2007. On a comparable basis, excluding the impact of currency fluctuation, order backlog decreased 18 percent compared to 2007. New sales orders written for 2008 were $1,927.7 million, a decrease of 16 percent compared to 2007, excluding the impact of currency fluctuations.

        Backlog information can vary as customers alter their sales order patterns. The 16 percent decrease in orders written in 2008 reflects the downturn experienced in almost all markets and regions during the fourth quarter of 2008. This downturn is also reflected in our order backlog which declined 18 percent excluding the impacts of currency.

Business Segment Results

        The following discussion of operating results by reportable segment relates to information as presented in Note 18 in the Notes to Consolidated Financial Statements. Segment income is defined as the respective segment's portion of the total Company's net income, excluding net interest expense, income taxes, minority interest, and global service expenses. Propel products include hydrostatic transmissions and related products that transmit the power from the engine to the wheel to propel a vehicle. Work Function products include steering motors as well as gear pumps and motors that transmit power for the work functions of the vehicle. Controls products include electrohydraulic controls, microprocessors, electric drives and valves that control and direct the power of a vehicle.

III-6


        The following table provides a summary of each segment's net sales and segment income, separately identifying the impact of currency fluctuations during the year.

 
  2007   Currency
fluctuation
  Underlying
change
  2008  
 
  (in millions)
 

Net sales

                         
 

Propel

  $ 940.7   $ 37.8   $ 38.1   $ 1,016.6  
 

Work Function

    534.0     26.0     1.4     561.4  
 

Controls

    497.8     21.2     (6.5 )   512.5  

Segment income (loss)

                         
 

Propel

  $ 146.6   $ 8.3   $ 1.9   $ 156.8  
 

Work Function

    (2.9 )   0.7     (63.5 )   (65.7 )
 

Controls

    17.7     0.0     (39.1 )   (21.4 )
 

Global Services and other expenses, net

    (51.1 )   (4.1 )   12.8     (42.4 )

Propel Segment

        The Propel segment experienced a 4 percent increase in sales, excluding the effects of currency fluctuations, during 2008. Segment income increased 1 percent during the same period. Segment income was negatively impacted by $2.3 million of severance costs, offset by a gain of $1.4 million related to the sale of a building. Field recall costs increased $1.5 million during 2008 and administrative costs increased $3.5 million. Restructuring costs of $5.5 million were recorded during 2007.

Work Function Segment

        Sales in the Work Function segment increased slightly, excluding the effects of currency fluctuations, during the year ended December 31, 2008. Sales increased 2 percent excluding the effects of both currency and the divestiture of product lines in Swindon, England in June 2007. Segment income was negatively impacted by goodwill impairment charges of $17.4 million. These charges were incurred as a result of lower profitability in the motors and steering reporting units than the Company had previously expected and lower future expectations in certain end markets. The Work Function segment incurred property, plant and equipment impairment charges of $35.3 million as a result of lower expected cash flow related to the products produced within the motors asset group. Segment income was also negatively impacted by severance costs of $6.5 million as a result of recent actions taken in response to the slowing economy.

Controls Segment

        Sales in the Controls segment decreased 1 percent for the year ended December 31, 2008, excluding the effects of currency fluctuations, compared to 2007. Segment income declined $33 million. This decrease is due to several factors, including an $8.4 million increase in field recall costs and a $6.8 million increase in fixed overhead costs due to increases in production capacity. Also contributing to the decline in segment income was an additional $4.5 million of research and development costs.

        During 2008, the Controls segment recognized $8.4 million of charges related to the expected sale of the AC electric motor business for the material handling market in 2009, goodwill impairment charges of $5.5 million, severance costs of $5.1 million, and a $0.4 million write-down of fixed assets related to the decision to close the facility in Hillsboro, Oregon. During 2007, the Controls segment recognized a loss of $6.6 million related to the sale of the DC electric motor business and $3.2 million of costs to reorganize the DC and AC electric motor business prior to the sale.

Global Services and other expenses, net

        Segment costs in Global Services and other expenses, net, relate to internal global service departments, along with the operating costs of the Company's executive office. Global services include such costs as consulting for special projects, tax and accounting fees paid to outside third parties, internal

III-7



audit, certain insurance premiums, and the amortization of intangible assets from certain business combinations. Global services and other expenses decreased $12.8 million excluding the impacts of currency, or 25 percent. This is primarily due to a $6.6 million reduction in incentive costs during the year ended December 31, 2008, a reduction of $4.6 million in costs associated with the implementation of the Company's common business system, and a $5.1 million reduction in losses related to foreign currency transactions.

Income Taxes

        The Company incurred income tax expense of $14.1 million on a loss of $15.1 million in 2008.

        In 2008 the Company recorded $22.9 million for the impairment of goodwill, of which $18.8 million was not deductible for income tax purposes and therefore no tax benefit was recorded on this expense. Valuation allowances and contingency reserves of $3.0 million were recorded as tax expense in 2008 which relates to impaired tax assets in the US, Italy and Germany. Other non-deductible expenses and the world-wide earnings mix also impacted the 2008 effective tax rate.

Executive Summary of 2007 Compared to 2006

        The following table summarizes the change in the Company's results from operations by separately identifying changes due to currency fluctuations and the underlying change in operations from 2006 to 2007. This analysis is more consistent with how the Company's management internally evaluates results.

 
  2006   Currency
fluctuations
  Underlying
change
  2007  
 
  (in millions)
 

Net Sales

  $ 1,739.1   $ 98.3   $ 135.1   $ 1,972.5  
 

Gross Profit

    396.8     24.5     6.4     427.7  
 

% of Net Sales

    22.8 %               21.7 %

Selling, general and administrative

    215.6     11.8     6.4     233.8  

Research and development

    61.9     3.5     5.2     70.6  

Impairment charges

    1.5         (1.5 )    

Loss on sale of businesses and asset disposals

    1.7         7.7     9.4  
                   
 

Total operating costs

    280.7     15.3     17.8     313.8  
                   
 

Operating income

    116.1     9.2     (11.4 )   113.9  
 

% of Net Sales

    6.7 %               5.8 %

Net interest expense

    (17.8 )   (1.0 )   (3.9 )   (22.7 )

Other expense, net

    (5.7 )   (2.3 )   4.4     (3.6 )
                   

Income before taxes and minority interest

    92.6     5.9     (10.9 )   87.6  

Minority interest

    (21.6 )   0.2     (0.2 )   (21.6 )
                   
 

Earnings before taxes

    71.0     6.1     (11.1 )   66.0  
 

% of Net Sales

    4.1 %               3.3 %
 

Income tax benefit (expense)

    (17.0 )   (0.6 )   (1.2 )   (18.8 )
                   

Net income

  $ 54.0   $ 5.5   $ (12.3 ) $ 47.2  
                   

        Net sales for the year ended December 31, 2007 increased 8 percent compared to the year ended December 31, 2006, excluding the effects of currency. Sales increased 10 percent excluding the effects of currency and the divestitures of product lines in Swindon, England and the direct current (DC) motor business. Sales increased in all regions and segments. Excluding the impacts of currency and divestitures, sales grew 14 percent in Europe, 13 percent in Asia Pacific, and 5 percent in the Americas. Sales in the Controls segment were up 17 percent. Sales in the Propel and Work Function segments were up 8 percent.

        Selling, general and administrative costs increased 3 percent during 2007 when compared to the same period in 2006, excluding the effects of currency. This increase is primarily attributed to $1.9 million costs

III-8



related to the start-up of a European financial shared services center, as well as increasing headcount, particularly for sales and marketing functions. Research and development costs increased $5.2 million excluding the impacts of currency, primarily driven by increasing product development, particularly in the Controls and Propel segments.

        During the year ended December 31, 2007 the Company incurred a loss of $6.6 million related to the sale of the DC electric motor business located in Berching, Germany and a loss of $2.4 million on the sale of the assets and product lines which were manufactured in Swindon, England. These activities were part of the Company's plan to divest of product lines that do not fit the Company's long-term strategic direction.

        During the year ended December 31, 2007, the Propel and Controls segments incurred $10.4 million of restructuring costs primarily to relocate production lines to other production facilities within the Company and remaining costs to close the LaSalle, Illinois plant. Restructuring charges incurred during the year ended December 31, 2006 were $13.5 million, primarily related to restructuring in the Propel and Work Function segments.

Operating Results—2007 Compared to 2006

Sales Growth by Market

        The following table summarizes the Company's sales growth by market. The table and following discussion is on a comparable basis, which excludes the effects of currency fluctuations.

 
  Americas   Asia-Pacific   Europe   Total  

Agriculture/Turf Care

    2 %   4 %   15 %   6 %

Construction/Road Building

    (11 )   17     13     4  

Material Handling/Specialty

    14     31     11     13  

Distribution

    8     9     8     8  

Agriculture/Turf Care

        Sales into the agriculture/turf care markets increased 6 percent during the year ended December 31, 2007 compared to 2006. Agriculture sales in Europe continue to be strong as a result of strong markets and favorable commodity prices. Agriculture sales increased in the Americas due to strengthening commodity prices resulting partly from rapidly expanding ethanol production. Increased sales into the Americas agriculture market were offset by decreased sales into the turf care market, primarily driven by the decline in housing starts and concerns regarding the slowing economic conditions.

Construction/Road Building

        Sales into the construction/road building markets increased 4 percent during 2007. The increase is driven by a 13 percent increase in the European construction/road building market due primarily to strong economic conditions, as well as a 17 percent increase in Asia-Pacific due to continued strength in the Chinese road building market. The increases in Europe and Asia-Pacific are offset by decreases in the Americas region, which is primarily the result of a reduction in new housing starts.

Material Handling/Specialty

        Specialty vehicles are comprised of a variety of markets including forestry, material handling, marine, waste management and waste recycling. All regions contributed to the sales growth in the specialty markets. Growth in the forestry market, particularly in eastern Europe, and demand for aerial lifts in the Americas were major contributors to the overall 13 percent increase in sales in 2007.

III-9


Distribution

        Products related to all of the above markets are sold to distributors, who then serve smaller OEMs.

Order Backlog

        The following table shows the Company's order backlog and orders written activity for 2006 and 2007, separately identifying the impact of currency fluctuations.

 
  2006   Currency
fluctuation
  Underlying
increase
  2007  
 
  (in millions)
 

Backlog at December 31

  $ 631.0   $ 50.4   $ 240.0   $ 921.4  

Orders written

    1,906.8     121.6     201.8     2,230.2  

        Total order backlog at the end of 2007 was $921.4 million, compared to $631.0 million at the end of 2006. On a comparable basis, excluding the impact of currency fluctuation, order backlog increased 38 percent over 2006. New sales orders written for 2007 were $2,230.2 million, an increase of 11 percent over 2006, excluding the impact of currency fluctuations.

        Backlog information can vary as customers alter their sales order patterns. The 11 percent increase in orders written in 2007 is reflective of the strong sales experienced during the year and backlog remains strong at the end of the year with over $920 million of customer orders received for future delivery.

Business Segment Results

        The following table provides a summary of each segment's net sales and segment income, separately identifying the impact of currency fluctuations during the year.

 
  2006   Currency
fluctuation
  Underlying
change
  2007  
 
  (in millions)
 

Net sales

                         
 

Propel

  $ 839.3   $ 32.7   $ 68.7   $ 940.7  
 

Work Function

    471.4     35.0     27.6     534.0  
 

Controls

    428.4     30.6     38.8     497.8  

Segment income (loss)

                         
 

Propel

  $ 111.8   $ 6.1   $ 28.7   $ 146.6  
 

Work Function

    16.5     1.1     (20.5 )   (2.9 )
 

Controls

    42.7     2.3     (27.3 )   17.7  
 

Global Services and other expenses, net

    (60.6 )   (2.9 )   12.0     (51.1 )

Propel Segment

        The Propel segment experienced an 8 percent increase in sales, excluding the effects of currency fluctuations, during 2007. Segment income increased 26 percent during the same period. The Propel segment showed a 2 percentage point increase in operating profit margin during 2007. This increase is due partly to a $3.3 million reduction in restructuring costs classified in cost of goods sold.

Work Function Segment

        Sales in the Work Function segment increased 6 percent, excluding the effects of currency fluctuations, during the year ended December 31, 2007. Despite the increase in sales, Work Function segment income decreased. Continued investment in a manufacturing improvement project in Denmark resulted in $4.1 million of charges. Operational issues contributed an additional $5.5 million of costs due primarily to increased order fulfillment charges and costs associated with work stoppages in Denmark. The weakening of the U.S. dollar during 2007 also had a negative impact on segment income as a result of product manufactured in euro-based countries and sold into the U.S. In March 2006, the Company

III-10



announced plans to discontinue production of certain product lines manufactured in the Swindon, England plant. Expense of $3.5 million was recognized during the year ended December 31, 2006 related to asset impairment and future employee termination payments. During 2007, the assets and product lines which were manufactured in Swindon, England were sold, and a loss on the sale of $2.4 million was recognized.

Controls Segment

        Net sales in the Controls segment for the year ended December 31, 2007, excluding the effects of currency fluctuations, increased 9 percent compared to 2006. Despite the increase in sales, segment income declined. The decline is mainly due to a loss of $6.6 million on the sale of the DC electric motor business in March 2007 and $3.2 million of costs to reorganize the DC and AC electric motor business prior to the sale. Expediting and overtime costs of $9.6 million were also incurred due to increased demand for certain products in the Controls segment. Research and development costs increased $3.1 million excluding the impacts of currency due primarily to continued investment in new product development.

Global Services and other expenses, net

        Global services and other expenses decreased $12.0 million excluding the impacts of currency, or 20 percent. This is primarily due to a $7.4 million reduction in incentive costs during the year ended December 31, 2007, as well as a reduction of $2.5 million in costs associated with the implementation of the Company's common business system.

Income Taxes

        The Company's effective tax rate was 28.5 percent in 2007 compared to 24.0 percent in 2006.

        The increase in the effective tax rate in 2007 is primarily related to unrecognized tax benefits of $2.2 million related to the sale of foreign assets.

Market Risk

        The Company is naturally exposed to various market risks, including changes in foreign currency exchange rates and interest rates.

Foreign Currency Changes

        The Company has operations and sells its products in many different countries of the world and therefore, conducts its business in various currencies. The Company's financial statements, which are presented in U.S. dollars, can be impacted by foreign exchange fluctuations through both translation risk and transaction risk. Translation risk is the risk that the financial statements of the Company, for a particular period or as of a certain date, may be affected by changes in the exchange rates that are used to translate the financial statements of the Company's operations from foreign currencies into U.S. dollars. Transaction risk is the risk from the Company receiving its sale proceeds or holding its assets in a currency different from that in which it pays its expenses and holds its liabilities.

        In previous years, the Company had been well balanced between its U.S. and European operations because the Company generated its sales in the same region in which it incurred its expenses, or shipped products between geographic regions on a balanced basis. However, in recent years the balance has shifted and the amount of sales made in U.S. dollars has increased, whereas the production costs are in a currency other than the U.S. dollar, increasing the Company's exposure to transaction risk. In 2008 the Company sold a total of $193.7 million into the U.S. of product that had been produced in European-based currencies compared to sales into Europe of $74.6 million of product produced in U.S. dollars. This imbalance had a significant impact on the results of the Company. In 2008 the results were unfavorable as the dollar weakened in comparison to other currencies. The Company produces and sells its product in several regions of the world, however the U.S. and European transactions comprise the majority of the imbalance between regions.

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        The Company enters into forward contracts to minimize the impact of currency fluctuations on cash flows related to forecasted sales denominated in currencies other than the functional currency of the selling location. The forecasted sales represent sales to both external and internal parties. Any effects of the forward contracts related to sales to internal parties are eliminated in the consolidation process until the related inventory has been sold to an external party. The forward contracts qualify for hedge accounting and therefore are subject to effectiveness testing at the inception of the contract and throughout the life of the contract. In 2008, as a result of hedge accounting for the forward contracts, the Company recognized an increase to net sales of $7.8 million and other expense of $0.5 million. The fair value of forward contracts included on the balance sheet at December 31, 2008 was a net liability of $3.3 million.

        The Company is also impacted by translation risk in terms of comparing results from period to period. Fluctuations of currencies against the U.S. dollar can be substantial and therefore, significantly impact comparisons with prior periods. Translation affects the comparability of both the income statement and the balance sheet. As shown in the table below, the translation impact on net sales was significant in 2008 and 2007 due particularly to the strengthening of the euro against the U.S. dollar.

 
  Percentage Sales Growth
Over Prior Year
 
 
  2008   2007   2006  

As Reported

    6.0 %   13.4 %   12.4 %

Without Currency Translation Impact

    1.7     7.8     11.8  

        The change in the exchange rate does affect the comparability of the balance sheet between 2008 and 2007 as the balance sheet accounts are translated at the exchange rate as of December 31. The U.S. dollar strengthened 3 percent against the euro and the Danish kroner from December 31, 2007 to December 31, 2008. The strengthening of the dollar has resulted in approximately 40 percent of the Company's total balance sheet being stated 3 percent lower than the prior year.

Interest Rate Changes

        The Company uses interest rate swap agreements on a limited basis to manage the interest rate risk on the total debt portfolio. The Company was a party to two interest rate swap agreements at December 31, 2008 with a combined notional amount of $34.0 million that require the Company to pay interest at a fixed rate and receive interest at a variable rate. The fair value of the interest rate swap agreements is recorded as a liability of $1.9 million on the balance sheet at December 31, 2008, with the offset recorded in accumulated other comprehensive income as the derivatives are accounted for using hedge accounting. The interest rate swap agreements mature in October 2010 and December 2011, but are expected to be terminated in 2009 in connection with the refinancing discussed in the Liquidity and Capital Resource section that follows.

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        The following table summarizes the maturity of the Company's debt obligations for fixed and variable rate debt (amounts in millions):

 
  Fixed Rate
Debt(1)
  Variable Rate
Debt
 

2009

  $ 1.5   $ 56.5  

2010

    145.7     167.9  

2011

    51.5     0.1  

2012

    1.2     0.1  

2013

    0.9     0.0  

2014 and Thereafter

    0.5     0.0  
           

Total

  $ 201.3   $ 224.6  
           

(1)
Includes total principal repayments of $34.0 million on variable rate debt. The rate has been fixed through the use of interest rate swaps.

Liquidity and Capital Resources

        The Company's principal sources of liquidity have been cash flow from operations and from its various credit facilities. The Company historically has accessed diverse funding sources, including short-term and long-term unsecured bank lines of credit in the United States, Europe, and Asia, as well as the private debt markets in the United States as discussed in Note 7 in the Notes to Consolidated Financial Statements.

        The Company determined, following the close of its 2008 fiscal year, that it would likely be unable to continue to meet the leverage ratio covenants in its various credit agreements as of the end of the first quarter of 2009. To avoid a default under the credit agreements, the Company has entered into a Credit Agreement with Danfoss A/S on March 12, 2009, pursuant to which the Company will have the ability to borrow up to $490 million (the "Danfoss Credit Agreement"). Danfoss A/S is the Company's majority stockholder. The Company intends to draw sufficient funds under the Danfoss Credit Agreement to refinance or repay certain of the Company's borrowings prior to default under any of the Company's credit agreements. As a result of the Danfoss Credit Agreement, the Company expects to have sufficient sources of liquidity to meet its future funding needs.

        At the time of filing this Annual Report on Form 10-K, the Company's multicurrency revolving credit facility remains outstanding. It provides up to $300 million of unsecured credit through December 2010, as well as a 40 million euro (approximately $55.6 million) term loan which expires in July 2013. At December 31, 2008 the Company had $201.9 million outstanding under the revolving credit facility. The Company is required to meet certain financial covenants under this facility as described in Note 7 in the Notes to Consolidated Financial Statements. The Company was in compliance with the covenants at December 31, 2008.

        If the global economy deteriorates further, it will likely have an unfavorable impact on demand for the Company's products, and as a result, on the Company's operating cash flow. The Company relies primarily on operating cash flow to provide for working capital needs of operations. However, as mentioned earlier, the Company has short-term and long-term debt facilities available to assist in meeting cash flow requirements if needed. The Company believes that the combination of internally generated funds and present capital resources are more than sufficient to meet cash requirements for 2009.

Cash Flows from Operations

        Cash provided by operations was $183.5 million in 2008 compared with $98.1 million in 2007. Cash increased as a result of a $71.7 million decrease in accounts receivable, excluding the effects of currency, due primarily to reduced sales levels at the end of 2008, as well as a $23.6 million increase in accrued

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liabilities, excluding currency, driven in part by accruals for severance costs and field recall programs. These changes were offset by a $16.8 million increase in inventory levels at the end of 2008 compared with the end of 2007, as well as discretionary pension contributions of $22.1 million.

        Total cash of the Company decreased $3.6 million from December 31, 2007 to December 31, 2008. At December 31, 2008 cash balances in China totaled $18.5 million, a decrease of $1.0 million from December 31, 2007. The Company is paying dividends from its Chinese entities to the maximum extent possible under current regulations; however, due to the nature of the governmental and other regulatory controls, it is difficult to move cash out of China for reasons other than payment for goods shipped into that country. As the Company continues to consider expanding its manufacturing capabilities in low-cost regions, it will make every effort to utilize the cash balances in those regions to fund future expansions. Total cash outside of China decreased by $2.6 million in 2008.

Cash Used in Investing Activities

        Capital expenditures for 2008 totaled $198.6 million. The high level of capital expenditures was driven over the past year by the need to add production capacity to address existing capacity constraints in a number of product lines. Although the downturn in business has changed the current capacity need, the Company believes that the investment will serve the Company well when the economy starts to strengthen again.

Cash Used in Financing Activities

        The Company paid quarterly dividends to stockholders totaling $34.7 million in 2008. In addition, the Company periodically makes distributions to its minority interest partners from its various joint venture activities with distributions totaling $13.9 million in 2008. The distributions can vary from year to year depending on the amount of undistributed earnings of the businesses and the needs of the partners. The Company borrowed an additional $48.3 million in 2008.

Contractual Cash Obligations

        The majority of the Company's contractual obligations to make cash payments to third parties are for financing obligations. These include future lease payments under both operating and capital leases. The following table discloses the Company's future commitments under contractual obligations as of December 31, 2008:

Contractual Cash Obligations(1)
  Total   2009   2010   2011   2012   2013   2014 and
Thereafter
 

Long-term debt(2)

  $ 425.9   $ 58.0   $ 313.6   $ 51.6   $ 1.3   $ 0.9   $ 0.5  

Interest on long-term debt(3)(4)

    36.4     11.6     22.6     2.0     0.1     0.1     0.0  

Capital leases

    19.2     1.5     1.3     1.1     1.1     0.8     13.4  

Operating leases

    81.9     14.3     13.2     12.5     7.3     6.2     28.4  

Rental and service agreements with related person Danfoss A/S

    57.1     9.1     9.1     9.1     9.1     8.9     11.8  
                               

Total contractual cash obligations

  $ 620.5   $ 94.5   $ 359.8   $ 76.3   $ 18.9   $ 16.9   $ 54.1  
                               

The following assumptions are used in the calculation of the contractual cash obligations:

(1)
Commitments denominated in a currency other than the U.S. dollar are translated at the December 31, 2008 exchange rate.

(2)
The table above reflects the payment terms of the new $490 million credit agreement as discussed in Note 19 in the Notes to the Consolidated Financial Statements, and assumes repayment of the

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    Multicurrency Term Loan Facility and the U.S. Senior Notes reported in the table in Note 7 to the Consolidated Financial Statements.

(3)
The annual amount borrowed under revolving credit agreements does not change from the $201.9 million borrowed at December 31, 2008, through the maturity date of the agreements.

(4)
The margin rate on variable interest rate debt does not change from December 31, 2008. The base interest rate for future years is based on the interest yield curves as of December 31, 2008.

        The $490 million credit agreement as discussed in Note 19 in the Notes to the Consolidated Financial Statements requires the Company to pay an upfront Facility Fee of 1.75 percent, or $8.6 million, as well as an annual commitment fee of 4 percent on any undrawn portion of the facility. This commitment fee is expected to be approximately $3.8 million in 2009 and $3.7 million in 2010. These amounts are not included in the table above.

        In addition to the above contractual obligations, the Company has certain other funding needs that are non-contractual by nature, including funding of certain pension plans. In 2009 the Company anticipates contributing $14.0 million to its pension and health benefit plans.

Other Matters

Critical Accounting Estimates

        The SEC's guidance surrounding the disclosure of critical accounting estimates requires disclosures about estimates a company makes in applying its accounting policies. However, such discussion is limited to "critical accounting estimates," or those that management believes meet two criteria: 1) the accounting estimate must require a company to make assumptions about matters that are highly uncertain at the time the accounting estimate is made, and 2) different estimates that the company reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the presentation of the company's financial condition, changes in financial condition or results of operations.

        Besides the estimates that meet the two criteria for a "critical estimate" above, the Company makes many other accounting estimates in preparing its financial statements and related disclosures. All estimates, whether or not deemed critical, can affect the reported amounts of assets, liabilities, revenues, and expenses as well as disclosures of contingent assets and liabilities. Estimates are based on experience and information available prior to the issuance of the financial statements. Materially different results can occur as circumstances change and additional information becomes known, including estimates not deemed "critical" under the SEC's guidance.

        The discussion below should be read in conjunction with disclosures elsewhere in this discussion and in the Notes to the Consolidated Financial Statements related to estimates, uncertainties, contingencies, and new accounting standards. Significant accounting policies are discussed in Note 1 to the Consolidated Financial Statements. The development and selection of accounting estimates, including those deemed "critical," and the associated disclosures in this discussion, have been discussed by management with the audit committee of the Board of Directors.

        Inventory Valuation    As a manufacturer in the capital goods industry, inventory is a substantial portion of the assets of the Company, amounting to over 20 percent of total assets at December 31, 2008. The Company must periodically evaluate the carrying value of its inventory to assess the proper valuation. This includes recording period adjustments as needed to 1) record expenses due to excess capacity, 2) provide for excess and obsolete inventory, and 3) ensure that inventory is valued at the lower of cost or market. On a quarterly basis, management within each segment performs an analysis of the underlying inventory to identify the need for appropriate write-downs to cover each of these items. In doing so, management applies consistent practices based upon historical data such as actual loss experience, past

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and projected usage, actual margins generated from trade sales of its products, and finally its best judgment to estimate the appropriate carrying value of the inventory.

        Warranty Provisions    The Company warrants its various products over differing periods depending upon the type of product and application. Consequently, the Company records liabilities for the estimated warranty costs that may be incurred under its basic warranty based on past trends of actual warranty claims compared to the actual sales levels to which those claims apply. These liabilities are accrued at the time the sales of the products are recorded. Factors that affect the Company's warranty liability include the number of units in the field currently under warranty, historical and anticipated rates of warranty claims on those units and the cost per claim to satisfy the Company's warranty obligation. The anticipated rate of warranty claims is the primary factor impacting the Company's estimated warranty obligation. Each quarter, the Company reevaluates its estimates to assess the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.

        In addition to its normal warranty liability, the Company, from time to time in the normal course of business, incurs costs to repair or replace defective products with a specific customer or group of customers. The Company refers to these as "field recalls" and in these instances, the Company will record a specific provision for the expected costs it will incur to repair or replace these products utilizing information from customers and internal information regarding the specific cost of materials and labor. Typically, field recalls are infrequent in occurrence, however, when they occur, field recalls can be for a large number of units and quite costly to rectify. Because of the sporadic and infrequent nature of field recalls, and due to the range of costs associated with field recalls, the Company cannot accurately estimate these costs at the time the products are sold. Therefore, these costs are recorded at the time information becomes known to the Company. As the field recalls are settled, the Company relieves the specific liability related to that field recall. These specific field recall liabilities are reviewed on a quarterly basis.

        Goodwill and Long-Lived Asset Recovery    A significant portion of the Company's total assets consist of property, plant and equipment (PP&E) and definite life intangibles, as well as goodwill. Changes in technology or in the Company's intended use of these assets, as well as changes in the broad global economy in which the Company operates, may cause the estimated period of use or the carrying value of these assets to change.

        This requires the Company to periodically assess the estimated useful lives of its assets in order to match, through depreciation and amortization, the cost of those assets with the benefits derived over the period of usefulness. The useful lives of these assets can be shortened through greater use due to volume increases, rapidly changing technology such as the use of electronics and computer-operated controls, and through inadequate maintenance. As of December 31, 2008 a ten percent change in the depreciable lives of the Company's assets would impact depreciation expense by approximately $11.0 million. Despite management's best efforts to determine the appropriate useful lives of its equipment, certain situations may arise that lead to an asset or group of assets becoming impaired, meaning their economic value becomes less than the value at which the Company is carrying the asset on its books. Examples of these situations are product rationalization efforts or restructuring of manufacturing facilities. When these situations arise, the Company tests the assets for impairment and will write down the asset in the period when the impairment becomes known. The Company determined that there was impairment in the long-lived assets of the motors asset group of $35.3 million in 2008. In addition, goodwill is tested for impairment at least annually.

        The Company completes its annual goodwill impairment valuation on December 31 each year. The Company has identified eight reporting units that are either operating segments or one level below operating segments. In performing the impairment valuation, the Company considers declines in market values, and reconciles the sum of the estimated fair values of its reporting units to the Company's market value (based on its stock price), plus a reasonable control premium, which is estimated as that amount

III-16



which would be received to sell the Company as a whole in an orderly transaction between market participants.

        When testing for goodwill impairment, the Company performs a first step of the goodwill impairment test to identify a potential impairment. In doing so, the Company compares the fair value of a reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, goodwill may be impaired and a second step is performed to measure the amount of any impairment loss. In the second step, the Company compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner that the amount of goodwill recognized in a business combination is determined. The Company allocates the fair value of a reporting unit to all of the assets and liabilities of that unit, including intangible assets, as if the reporting unit had been acquired in a business combination. Any excess of the value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. The Company determined that the implied fair value of goodwill for the motors, steering, and electric drives reporting units was less than their carrying values by $22.9 million, which was recorded as a goodwill impairment charge in 2008.

        Estimates about fair value used in the first step of the goodwill impairment tests are calculated using an income approach based on the present value of future cash flows of each reporting unit. The income approach has been supported by other valuation approaches, such as similar transaction and guideline analyses. Under the income approach, the Company determines fair value based on estimated future cash flows of each reporting unit, discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of a reporting unit and the rate of return an outside investor would expect to earn. Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and operating margins, discount rates and future market conditions among others. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairments in future periods. At December 31, 2008 the Company had $86.1 million of goodwill related to its propel, valves and mobile electronics reporting units.

        Given the current economic environment and the uncertainties regarding the impact on the Company's business, there can be no assurance that the Company's estimates and assumptions regarding the duration of the ongoing economic downturn, or the period or strength of recovery, made for purposes of the Company's goodwill impairment testing as of December 31, 2008 will prove to be accurate predictions of the future. If the Company's assumptions regarding forecasted revenue or margin growth rates of certain reporting units are not achieved, or the Company's stock price continues to decline, the Company may be required to record additional goodwill impairment charges in future periods, whether in connection with the next annual impairment test or if a triggering event requires an earlier impairment test to be performed. It is not possible at this time to determine if any such future impairment charge would result, or if it does, whether the charge would be significant. However, given recent downward movement in the Company's stock price during the first quarter of 2009, an additional impairment charge may be recorded.

        Valuation of Trade Receivables    The Company records trade receivables due from its customers at the time a sale is recorded in accordance with its revenue recognition policy. The future collectability of these amounts can be impacted by the Company's collection efforts, the financial stability of its customers, and the general economic climate in which it operates. The Company applies a consistent practice of establishing an allowance for accounts that it believes may become uncollectible through reviewing the historical aging of its receivables, looking at the historical losses incurred as a percentage of net sales, and by monitoring the financial strength of its customers. In addition, local customary practices have to be taken into account due to varying payment terms being applied in various parts of the world where the Company conducts its business. If the Company becomes aware of a customer's inability to meet its

III-17



financial obligations (e.g., where it has filed for bankruptcy), the Company establishes a specific allowance for the potential bad debt to reduce the net recognized receivable to the amount it reasonably believes will be collected. The valuation of trade receivables is performed quarterly.

        Workers Compensation    The Company has an insurance policy to cover workers compensation claims in the United States, in which the Company pays the first $0.25 million per claim, per incident. The Company establishes its workers compensation reserve based on historic growth factors of claims and an estimate of incurred, but not reported claims. This analysis is performed on a quarterly basis.

        U.S. Health Care Costs    The Company self insures its U.S. health care costs for eligible employees and their qualified dependents with exposure for any one year, excluding prescription costs, limited to $0.2 million per individual. The Company establishes reserves for its health care cost based on historic claims data and an estimate of incurred, but not reported claims. This analysis is performed on a quarterly basis.

        Pensions    The Company has noncontributory defined benefit pension plans for a portion of its employees. In certain countries, such as the United States and the United Kingdom, these plans are funded with plan assets whereas in other countries such as Germany, the plans have historically been unfunded, which is customary. In 2007 the Company started contributing to the German pension plans. The measurement of the Company's pension obligations and costs is dependent on a variety of assumptions determined by management and used by the Company's actuaries. These assumptions include estimates of the present value of projected future pension payments to all plan participants, taking into consideration the likelihood of potential future events such as salary increases and other experience. These assumptions may have an effect on the amount and timing of future contributions. The plan trustee conducts an independent valuation of the fair value of pension plan assets.

        The assumptions used in developing the required estimates include the following key factors:

Discount rates

  Inflation

Salary growth

  Expected return on plan assets

Retirement rates

  Mortality rates

        The Company bases the discount rate assumption on investment yields available at or near year-end on corporate long-term bonds rated AA. The inflation assumption is based on an evaluation of external market indicators. The salary growth assumptions reflect the Company's long-term actual experience, the near-term outlook and assumed inflation. The expected return on plan assets reflects asset allocations, investment strategy, and the views of investment managers and other large pension plan sponsors. Retirement and mortality rates are based primarily on actual plan experience and standard industry actuarial tables, respectively. The effects of actual results differing from our assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense in such future periods.

        The Company's funding policy for the U.S. plans are to contribute amounts sufficient to meet the minimum funding requirement of the Employee Retirement Income Security Act of 1974, plus any additional amounts the Company may deem to be appropriate. In 2009 the Company anticipates contributing $8.4 million to its U.S. plans, $2.0 million to its German plans, and $0.5 million to its U.K. plans.

        Postretirement Benefits Other Than Pensions    The Company provides postretirement health care benefits for certain employee groups in the United States. This plan is contributory and contains certain other cost-sharing features such as deductibles and coinsurance. The Company does not pre-fund this plan and has the right to modify or terminate this plan in the future.

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        The postretirement liability, which is determined on an actuarial basis, is recognized in the Company's Consolidated Balance Sheets and the postretirement expense is recognized in the Consolidated Statements of Income. The Company must determine the actuarial assumption for the discount rate used to reflect the time value of money in the calculation of the accumulated postretirement benefit obligation for the end of the current year and to determine the postretirement cost for the subsequent year. For guidance in determining this rate, the Company looks at investment yield trends available near year-end on corporate bonds rated AA. In addition, the Company must determine the actuarial assumption for the health care cost trend rate used in the calculation of the accumulated postretirement benefit obligation for the end of the current year and to determine the net periodic postretirement benefit cost for the subsequent year. As of December 31, 2008 a one-percentage-point change in the assumed health care cost trend rate would impact the expense recognized in 2008 by $0.2 million and would affect the postretirement benefit obligation by $3.1 million. In 2009 the Company anticipates contributing $3.1 million to this plan.

        Deferred Income Taxes and Valuation Allowances    Tax regulations may require items to be included in the tax return at different times than the items are reflected in the financial statements. Some of the differences are permanent, such as expenses that are not deductible on a tax return, and some of the differences are temporary such as the rate of depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally are attributable to items that can be used as a tax deduction or credit in a tax return in future years but the amount has already been included as an expense in the financial statements. Deferred tax liabilities generally represent deductions that have been taken on the tax return but have not been recognized as expense in the financial statements. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Management believes it is more likely than not that the Company will realize the benefits of the net deferred tax assets reported on the consolidated balance sheets.

New Accounting Policies

        In September 2006, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 157, "Fair Value Measurements" which clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. SFAS No. 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. The Company has adopted the provisions of SFAS No. 157 as of January 1, 2008 for financial instruments. Although the adoption of SFAS No. 157 did not materially impact its consolidated financial condition, results of operations, or cash flow, the Company is now required to provide additional disclosures as part of its consolidated financial statements which are included in Note 12 to the Consolidated Financial Statements.

        The FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115" in February 2007. SFAS No. 159 permits many financial instruments and certain other items to be measured at fair value at the option of the Company. The Company adopted SFAS No. 159 as of January 1, 2008 with no impact on the consolidated financial statements.

        SFAS No. 141R "Business Combinations" replaces SFAS No. 141, and establishes requirements for recognition and measurement of identifiable assets acquired, liabilities assumed, noncontrolling interest of the acquiree, goodwill acquired, and gain from bargain purchase. SFAS No. 141R was issued in December 2007 and applies prospectively to business combinations for which the acquisition date is on or after the beginning of the annual reporting period beginning on or after December 15, 2008. The Company will adopt SFAS No. 141R in 2009.

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        The FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51" in December 2007. SFAS No. 160 was issued to improve the relevance, comparability, and transparency of financial information provided to investors by requiring all entities to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company is currently evaluating the impact that SFAS No. 160 will have on its consolidated financial statements and disclosures.

        SFAS No. 161 "Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133" was issued by the FASB in March 2008. SFAS No. 161 amends and expands disclosure requirements for derivative instruments in order to provide users of financial statements with an enhanced understanding of (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and its related interpretations and (iii) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. SFAS No. 161 is to be applied prospectively for the first reporting period beginning on or after November 15, 2008. The Company will include the expanded disclosures in its consolidated financial statements beginning in 2009.

        In May 2008, the FASB issued SFAS No. 162 "The Hierarchy of Generally Accepted Accounting Principles" which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements for nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. SFAS No. 162 became effective on November 15, 2008, sixty days following approval by the Securities and Exchange Commission. Adoption of SFAS No. 162 did not have a material effect on the Company's consolidated financial statements.

        The FASB issued FASB Staff Position (FSP) Emerging Issues Task Force (EITF) No. 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transaction Are Participating Securities" in June 2008. FSP EITF 03-6-1 provides guidance on the calculation of earnings per share and indicates that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends or dividend equivalents are considered participating securities and therefore the two-class method should be applied in calculating basic and diluted earnings per share. FSP EITF No. 03-6-1 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company is currently evaluating the impact that FSP EITF No. 03-6-1 will have on its consolidated financial statements.

Non-Audit Services of Independent Registered Public Accounting Firm

        The Company's Independent Registered Public Accounting Firm, KPMG LLP, performed the following non-audit services that have been approved by the Audit Committee of the Board of Directors: international tax planning and compliance services, expatriate tax services for persons not in a financial reporting oversight role, and statutory audits and related matters.

Outlook

        The worldwide recession and credit market turmoil is affecting all regions and markets that the Company operates in and serves. Management expects sales to decline in virtually all regions and markets in 2009 compared to 2008 and does not expect an upturn before 2010. Management will be focused on cost reduction, conserving cash and sizing the business for forecasted sales levels.

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Sauer-Danfoss Inc. and Subsidiaries

Consolidated Statements of Operations

(Dollars in thousands, except per share data)

 
  For the Years Ended December 31,  
 
  2008   2007   2006  

Net sales

  $ 2,090,513   $ 1,972,548   $ 1,739,088  

Cost of sales

    1,654,903     1,544,846     1,342,324  
               
 

Gross profit

    435,610     427,702     396,764  
 

Selling, general and administrative

    258,491     233,809     215,565  
 

Research and development

    82,915     70,552     61,880  
 

Impairment charges

    58,208         1,547  
 

Loss on sale of businesses and asset disposals

    9,604     9,412     1,699  
               
   

Total operating expenses

    409,218     313,773     280,691  
               
   

Operating income

    26,392     113,929     116,073  
               

Nonoperating Income (Expenses):

                   
 

Interest expense

    (25,654 )   (23,789 )   (18,415 )
 

Interest income

    1,026     1,048     654  
 

Other, net

    966     (3,589 )   (5,675 )
               
   

Nonoperating expenses, net

    (23,662 )   (26,330 )   (23,436 )
               

Income Before Income Taxes and Minority Interest

    2,730     87,599     92,637  

Minority Interest

    (17,811 )   (21,562 )   (21,617 )
               

Income (Loss) Before Income Taxes

    (15,081 )   66,037     71,020  

Income Tax Expense

    (14,060 )   (18,839 )   (17,021 )
               
   

Net Income (Loss)

  $ (29,141 ) $ 47,198   $ 53,999  
               

Net Income (Loss) per common share, basic

  $ (0.60 ) $ 0.98   $ 1.13  
               

Net Income (Loss) per common share, diluted

  $ (0.60 ) $ 0.98   $ 1.12  
               

Weighted average basic shares outstanding

    48,226,184     48,094,375     47,699,972  

Weighted average diluted shares outstanding

    48,226,184     48,326,637     48,237,814  

See accompanying notes to consolidated financial statements.

III-21



Sauer-Danfoss Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except per share data)

 
  December 31,  
 
  2008   2007  

Assets

             

Current Assets:

             
 

Cash and cash equivalents

  $ 23,145   $ 26,789  
 

Accounts receivable (net of allowances of $5,210 and $5,133 in 2008 and 2007, respectively)

    239,881     318,152  
 

Inventories

    326,688     318,836  
 

Other current assets

    50,754     62,623  
           
   

Total current assets

    640,468     726,400  
           

Property, Plant and Equipment, net

   
598,435
   
562,818
 
           

Other Assets:

             
 

Goodwill

    86,146     114,500  
 

Other intangible assets, net

    23,971     25,295  
 

Deferred income taxes

    106,984     61,680  
 

Other

    11,672     9,729  
           
   

Total other assets

    228,773     211,204  
           

  $ 1,467,676   $ 1,500,422  
           

Liabilities and Stockholders' Equity

             

Current Liabilities:

             
 

Notes payable and bank overdrafts

  $ 65,512   $ 59,415  
 

Long-term debt due within one year

    58,005     208,819  
 

Accounts payable

    149,512     168,015  
 

Accrued salaries and wages

    79,322     61,961  
 

Accrued warranty

    25,491     19,401  
 

Other accrued liabilities

    42,075     46,996  
           
   

Total current liabilities

    419,917     564,607  

Long-Term Debt

   
367,922
   
175,811
 
           

Other Liabilities

             
 

Long-term pension liability

    90,966     70,777  
 

Postretirement benefits other than pensions

    37,971     35,935  
 

Deferred income taxes

    44,243     40,930  
 

Other

    28,756     26,318  
           
   

Total other liabilities

    201,936     173,960  
           
 

Total liabilities

    989,775     914,378  
           

Minority Interest in Net Assets of Consolidated Companies

   
67,655
   
60,544
 
           

Stockholders' Equity:

             
 

Preferred stock, par value $.01 per share, authorized 4,500,000 shares, no shares issued or outstanding

         
 

Common stock, par value $.01 per share, authorized shares 75,000,000 in 2008 and 2007;
issued and outstanding 48,271,806 in 2008 and 48,149,461 in 2007

    483     481  
 

Additional paid-in capital

    334,847     332,522  
 

Retained earnings

    46,921     110,812  
 

Accumulated other comprehensive income

    27,995     81,685  
           
   

Total stockholders' equity

    410,246     525,500  
           

  $ 1,467,676   $ 1,500,422  
           

See accompanying notes to consolidated financial statements.

III-22



Sauer-Danfoss Inc. and Subsidiaries

Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)

(Dollars in thousands, except per share data)

 
  Number of Shares Outstanding   Common Stock   Additional Paid-in Capital   Retained Earnings   Accumulated Other Comprehensive Income   Total  

Year Ended December 31, 2006:

                                     

Beginning Balance

    47,498,232   $ 475   $ 333,392   $ 72,924   $ 26,911   $ 433,702  
                           

Comprehensive income:

                                     
 

Net income

                53,999            
 

Pension and postretirement adjustment

                    (10,178 )      
 

Unrealized gains on hedging activities

                    847        
 

Currency translation

                    38,089        

Total comprehensive income

                                  82,757  
 

Tax adjustment related to shares issued to minority interest partner

            285             285  
 

Performance units vested

    234,547     2     (2 )            
 

Restricted stock grant

    13,500                      
 

Restricted stock and performance unit compensation

            6,294             6,294  
 

Tax benefits on performance unit compensation

                137                 137  
 

Minimum tax withholding settlement

            (3,144 )           (3,144 )
 

Cash dividends declared ($.60 per share)

                (28,646 )       (28,646 )
 

Adjustment to adopt FASB Statement No. 158, net of tax of $11,804

                    (29,326 )   (29,326 )
                           

Balance December 31, 2006

    47,746,279     477     336,962     98,277     26,343     462,059  
                           

Year Ended December 31, 2007:

                                     
 

Net income

                47,198            
 

Pension and postretirement adjustment

                    12,462        
 

Unrealized gains on hedging activities

                    2,144        
 

Currency translation

                    40,736        

Total comprehensive income

                                  102,540  
 

Performance units vested

    379,682     4     (4 )            
 

Restricted stock grant

    23,500                      
 

Restricted stock and performance unit compensation

            4,390             4,390  
 

Tax benefits on performance unit compensation

            145             145  
 

Minimum tax withholding settlement

            (8,971 )           (8,971 )
 

Cash dividends declared ($.72 per share)

                (34,663 )       (34,663 )
                           

Balance December 31, 2007

    48,149,461     481     332,522     110,812     81,685     525,500  
                           

Year Ended December 31, 2008:

                                     
 

Net loss

                (29,141 )          
 

Pension and postretirement adjustment

                    (22,440 )      
 

Unrealized losses on hedging activities

                    (6,861 )      
 

Currency translation

                    (24,389 )      

Total comprehensive loss

                                  (82,831 )
 

Performance units vested

    110,837     2     (2 )            
 

Restricted stock grant

    15,000                      
 

Restricted stock and performance unit compensation

            (2,070 )           (2,070 )
 

Tax benefits on performance unit compensation

            1,534